The Measurement and Calculation of Inflation Module 15

Learning Objectives 1.How the inflation rate is measured. 2.What a price index is and how it is calculated. 3.The importance of the consumer price index and other price indexes.

Key Economic Concepts 1.Inflation is a broad measure of how fast overall prices in the economy are rising. It’s important to understand that some goods may actually be falling in price, yet overall the economy is experiencing inflation. 2.Creation of a price index allows economists to track changes to the overall price of a market basket of items. 3.Price index in year t = 100 * (cost of the market basked in year t) / (cost of the market basket in the base year) 4.Consumer inflation is the rate of increase in the CPI 5.Inflation rate this year = 100 * (CPI this year – CPI last year) / (CPI last year)

Common Student Difficulties The whole idea of a price index is confusing. Practice computing the inflation rate with actual CPI numbers.

Market Basket Typical basket of g&s purchased = market basket

How to calculate a price index Price index in year t = 100 *(cost of market basket year t) / (cost of market basket in base year)

Consumer Price Index CPI = most widely used measure of price inflation – Computed every month – 80,000 g&s for a typical urban family of 4

Other Price Indices Producer Price Index (PPI): measures the cost of a typical basket of g&s containing raw commodities such as steel, electricity, coal, etc., purchased by producers. GDP Deflator = an economic measure (not a price index) that tracks the cost of good produced in an economy relative to the purchasing power of the dollar GDP Deflator = (NGDP/RGDP) x 100