MEASURING INFLATION AND DEFLATION

For dummies

THE CONSUMER PRICE INDEX

Straight from IB GUIDE:*Explain that inflation and deflation are typically measured by calculating a consumer price index (CPI), which measures the

change in prices of a basket of goods and serviced consumed by the average household

• Price index: measure of average prices in one period relative to average prices in reference period called a base period

• One of the most commonly used price indices to measure inflation is CPI

CPI-what is it, how it’s constructed

• CPI is a measure of the cost of living, or the cost of goods and services purchased by the typical household in an economy.

• It’s constructed by a statistical service in each country: it creates a hypothetical basket of goods that are consumed by a typical household during the year (price x quantity=total value of basket). Then the value of the same basket is calculated for subsequent years. CPI shows how the value of the basket changes from year to year by comparing its value with the base year.

SUMMING UP

• The consumer price index (CPI) is a measure of the cost of living for the typical household and compares the value of a basket of goods and services in one year with the value of the same basket in a base year. Inflation( and deflation) are measured as a percentage change in the value of the basket from one year to another. A positive percentage change indicates inflation. A negative percentage change indicates deflation.

PROBLEMS WITH CPI

*Explain that different income earners may experience a different rate of inflation when their pattern of consumption is not accurately reflected by CPI

*Explain that inflation figures may not accurately reflect changes in consumption patters and the quality of the products purchased

,,Typical basket” problems

•Different rates of inflation for different income earners

•Different rates of inflation depending on regional or cultural factors

•Changes in consumption patters due to consumer substitutions when relative price changes

•Changes in consumption patterns due to increasing use of discount stores and sales.

•Changes in consumption patterns due to introduction of new products

•Changes in product quality

• International comparisons

•Comparability over time

THE CORE RATE OF INFLATION

*Explain that economists measure a core/underlying rate of inflation to eliminate the effect of sudden swings in the prices of food and oil

Highly volatile prices may give rise to misleading interpretation about inflation.SOLUTION: Don’t include products with highly volatile prices in CPI (products such as food and energy)

THE PRODUCER PRICE INDEX

*Explain that a producer price index measuring changes in the prices of factors of production may be useful in predicting future

inflation.

Producer price index (PPI)- several indices of prices received by producers of goods at various stages in the production process for example:- PPI for inputs- PPI for intermediate goods- PPI for final goodsPPI measures price level changes from the point of view of producer rather than consumers.

NOW U KNOW ALL ABOUT MEASURING THE RATE OF

INFLATION AND DEFLATION.*magic*