1. Inflation and The Consumer Price Index
Unit Two:
Inflation and The Consumer Price Index

2. Goals Explain the impact of inflation on real wages and real income.
Calculate the market basket, CPI, and the inflation rate of an economy.

3. I. Inflation Inflation Rate Real Wage Real Income
The percent change per year in a price index– typically the consumer price index.
Real Wage
The wage rate/ the price level
Real Income
Income/ price level
Real wage and real income depend upon how prices are changing everywhere. If income or wages decrease and prices around you decrease to the same degree, real wage and real income stay the same.
Inflation rate: take a look at the prices of goods in a market basket to decide how prices in general are changing.

4. II. Measuring Price Level
Aggregate Price Level
A measure of the overall level of prices in the economy.
Market Basket
A hypothetical set of consumer purchases of goods and services.
Consumer Price Index
Measures the cost of the market basket of a typical urban American family.
Typically overstated
Base period is ; done by the Bureau of Labor Statistics by sending employees to check prices in 87 cities at retail outlets
When goods become too expensive consumers substitute them for cheaper goods; but the market basket does not tend to take that into account when calculating the market basket.
Innovation takes place, so we now have new goods or better quality goods to purchase with our money that we have nothing to truly compare the past to.

5. III. Calculating Inflation and CPI
Market Basket:
(Fixed Quantity of Market Basket goods * Price level of the year)
Add together all of the goods of a given year to find the total cost of the Market Basket.
When finding the cost of a market basket, the quantity must remain the same when comparing years.

6. III. Calculating Inflation and CPI
Price Index of a given year:
(Cost of the market basket in a given year
Cost of market basket in a base year)100
Numbers on the board for calculating the market basket.

7. III. Calculating Inflation and CPI
Inflation Rate:
(Current year – Base year
Base year) 100
Can use either the price index of two given years or the overall price level, depending upon information given.

8. IV. Practice
1. Suppose the year 2000 is the base year for a price index. Between and 2020 prices double and at the same time your nominal income increases from $40,000 to $80,000.
What is the value of the price index in 2000?
What is the value of the price index in 2020?
What is the percentage increase in your nominal income between 2000 and 2020?
What has happened to your real income between 2000 and 2020? Explain.

9. IV. Practice
2. If the cost of a market basket of goods increases from $100 in year 1 to $108 in year 2, the consumer price index in year 2 equals _____ if year 1 is the base year. 8 10
100
108
110 D

10. IV. Practice
3. If the consumer price index increases from 80 to 120 from one year to the next, the inflation rate over that time period was
20%
40%
50%
80%
120% C

11. IV. Practice 4. Which of the following is true of the CPI?
It is the most common measure of the price level.
It measures the price of a typical market basket of goods.
It currently uses a base period of
I only
II only
III only
I and II only
I, II, and III E

12. IV. Practice 5. The value of a price index in the base year is 100 200
100
200
The inflation rate
The average cost of a market basket of goods. B

13. IV. Practice
6. If your wage doubles at the same time as the consumer price index goes from 100 to 300, your real wage
Doubles
Falls
Increases
Stays the same
Cannot be determined B