Inflation
Inflation = a persistent rise in the general, or average level of prices >> decline in the
purchasing power of money
Disinflation = when the rate of inflation falls (NOT the same as deflation as prices are still rising
just at a lower rate)
Persistent rise – a single increase in prices due to supply shock is NOT inflation
Purchasing power of money = how much goods/services you can buy with your money
DEMAND pull inflation
= the result of when rises in AD are greater than the country’s ability to produce goods/services
æ People feel wealthier >> higher level of consumption
æ Fall in interest rates
æ Decreasing taxes (tax breaks)
æ Government printing money << increasing gov debt
COST push inflation
= the result of a rise in production costs
æ Increased price in raw materials (and other factors of production)
æ Caused by a fall in AS
æ Workers asking for higher wages (union resistance)
æ Increased cost of land
THE CONSUMER PRICE INDEX:
= a measure of the cost of living for the typical household
current Backet value
= x 100
Base basket value
- Compares the value of a basket of goods/services in one year with the value of the same
basket in one year.
- basket = sum of P x Q for each good/service in the basket
- Inflation & deflation are measured as a ∆% in the basket value from 1 year to another.
- +∆% indicates inflation
- -∆% indicates deflation
, CONSTRUCTING A WEIGHTED PRICE INDEX
1. Decide which year will be the base year
2. Use the price of each good/service in the base year to calculate their base year value
3. Calculate the sum of the basket goods values in the base year
4. Calculate the value (P x Q) for each good/service in the following year (and etc.)
5. Calculate the sum of the basket goods values in the following years
To construct a weighted price index
1. Find the value of the basket in current priced for each year
2. value of the basket for each year ÷ the value of the basket in the base year
3. = price index number for each year
USING THE CPI TO CALCULATE INFLATION RATE
(Variable A = CPI)
When the price level is presented as a price index, the rate of inflation is equal to the index
number of any year minus the index number of the base year
• RPI (Retail price index) takes into consideration = mortgage payments, rents,
council tax (but CPI does not)
• Headline inflation rate = most commonly used to assess the state of the economy
• Core inflation rate = excludes energy and food prices from the basket of goods as
they can be volatile and create large and abrupt price changes
DISADVANTAGES OF CPI
- Can only calculate inflation rates from a price index constructed by use of the same
basket.
- Cannot make comparisons of APLs across years by use of price indices with a different
base year.
- Rate of CPI reflects the change in average prices, however different consumers have
different consumption patterns.
- Regional or cultural factors change consumption patterns
- Consumer substitutions change consumption wpatterns.
- Changes in consumption patters due to discount stores and sales
- Changes in consumption patterns due to the introduction of new products
- Changes in product quality are not accounted for.
- International comparisons cannot be made as CPIs are different for each country.
- Comparability over time is not possible as countries periodically revise their CPI baskets
and base years.
- Statistical errors due to large volumes of data
PRODUCER PRICE INDEX (PPI)
Inflation = a persistent rise in the general, or average level of prices >> decline in the
purchasing power of money
Disinflation = when the rate of inflation falls (NOT the same as deflation as prices are still rising
just at a lower rate)
Persistent rise – a single increase in prices due to supply shock is NOT inflation
Purchasing power of money = how much goods/services you can buy with your money
DEMAND pull inflation
= the result of when rises in AD are greater than the country’s ability to produce goods/services
æ People feel wealthier >> higher level of consumption
æ Fall in interest rates
æ Decreasing taxes (tax breaks)
æ Government printing money << increasing gov debt
COST push inflation
= the result of a rise in production costs
æ Increased price in raw materials (and other factors of production)
æ Caused by a fall in AS
æ Workers asking for higher wages (union resistance)
æ Increased cost of land
THE CONSUMER PRICE INDEX:
= a measure of the cost of living for the typical household
current Backet value
= x 100
Base basket value
- Compares the value of a basket of goods/services in one year with the value of the same
basket in one year.
- basket = sum of P x Q for each good/service in the basket
- Inflation & deflation are measured as a ∆% in the basket value from 1 year to another.
- +∆% indicates inflation
- -∆% indicates deflation
, CONSTRUCTING A WEIGHTED PRICE INDEX
1. Decide which year will be the base year
2. Use the price of each good/service in the base year to calculate their base year value
3. Calculate the sum of the basket goods values in the base year
4. Calculate the value (P x Q) for each good/service in the following year (and etc.)
5. Calculate the sum of the basket goods values in the following years
To construct a weighted price index
1. Find the value of the basket in current priced for each year
2. value of the basket for each year ÷ the value of the basket in the base year
3. = price index number for each year
USING THE CPI TO CALCULATE INFLATION RATE
(Variable A = CPI)
When the price level is presented as a price index, the rate of inflation is equal to the index
number of any year minus the index number of the base year
• RPI (Retail price index) takes into consideration = mortgage payments, rents,
council tax (but CPI does not)
• Headline inflation rate = most commonly used to assess the state of the economy
• Core inflation rate = excludes energy and food prices from the basket of goods as
they can be volatile and create large and abrupt price changes
DISADVANTAGES OF CPI
- Can only calculate inflation rates from a price index constructed by use of the same
basket.
- Cannot make comparisons of APLs across years by use of price indices with a different
base year.
- Rate of CPI reflects the change in average prices, however different consumers have
different consumption patterns.
- Regional or cultural factors change consumption patterns
- Consumer substitutions change consumption wpatterns.
- Changes in consumption patters due to discount stores and sales
- Changes in consumption patterns due to the introduction of new products
- Changes in product quality are not accounted for.
- International comparisons cannot be made as CPIs are different for each country.
- Comparability over time is not possible as countries periodically revise their CPI baskets
and base years.
- Statistical errors due to large volumes of data
PRODUCER PRICE INDEX (PPI)
