1. The Measurement and Calculation of Inflation
AP Economics
Mr. Bernstein
Module 15:
The Measurement and Calculation of Inflation
February 2, 2015

2. AP Economics Mr. Bernstein
Measurement and Calculation of Inflation
Objectives - Understand each of the following:
How the inflation rate is measured
What a price index is and how it is calculated
The importance of the Consumer Price Index and other price indexes

3. AP Economics Mr. Bernstein
Price Indexes and the Aggregate Price Level
Market Basket is made
up of typical goods and
services purchased
Measuring broad level
of inflation, not individual
goods and services

4. AP Economics Mr. Bernstein
Market Baskets and Price Indexes
Price index in a given year =
(cost of the market basket in year t)/(cost of the market basket in the base year)
Inflation rate = percentage change between any two values of the index, ie (CPI CPI2012) / CPI2012
Note: Index value in base year = 100

5. AP Economics Mr. Bernstein
Example: The Deli Index
2012 cost = (300*4)+(200*5)+(100*2)+(500*3)=3900
2013 cost = (300*6)+(200*7)+(100*1.5)+(500*2.5)=4600
DPI (Deli Price Index) increased (4600/3900)-1 = ~18% even though 2 items actually declined in price
Item in the Deli Basket
Quantity Consumed in a Typical Year
2012 Price per Pound
2013 Price per Pound
Corned Beef
300 $4 $6
Salami
200 $5 $7
Turkey
100 $2
$1.50
Cheese
500 $3
$2.50

6. AP Economics Mr. Bernstein
Consumer Price Index (CPI)
Computed monthly using a market basket of ~80,000 goods and services consumed by a typical urban family
Most widely used measure of inflation
Producer Price Index (PPI) measures inflation in inputs used by businesses rather than final products
GDP Deflator (Ratio of Nominal GDP to Real GDP) often used in same way, although technically its not an index.
Note: Base year for GDP is currently 2000

7. AP Economics Mr. Bernstein
Coincidence of Inflation Measures