inflation and cpi

8/2/2019 Inflation and CPI

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Macroeconomic

Problems

Inflation

Economics


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What is Inflation?

The general upward movement in theaverage level of prices of the goods andservices in an economy


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What is Deflation?

The general decreasein the average level of

prices of the goodsand services in aneconomy


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How is Inflation measured?

Consumer Price Index (CPI)?

A measure of the cost of a

fixed market basket ofconsumer goods andservices


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Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]

The CPI is a market basket of364 items at 21,000establishments in 91 cities that the typicalhouseholder buys. It does not include exportsbecause we do not buy exports but does include

imports. About 55% of the CPI is services.


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CPI in Indonesia

Since June 2008, the CPIcalculation uses base year of2007 (2007 = 100) and covers66 cities.

The data cover 284 - 441 goodsand services which areclassified into sevenexpenditure groups namely:

1. food; prepared food, beverage,

2. cigarette & tobacco;3. housing, water, electricity, gas

& fuel;

4. clothing;

5. health;

6. education, recreation & sports;and

7.transport, communication &financial services.


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How is the CPI calculated?

Value of the market basket

in the current period

x 100 = PRICE INDEX

Value of the market basket in

the base period

CPI =

C


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Consumers in this economy buy only two goodshot dogs & hamburgers.Step 1. Fix the basket. What percent of income is spent on each.

Consumers in this economy buy a basket of:

4 hot dogs and 2 hamburgers

Step 2. Find the prices of each good in each year.Year Price of Hot Dogs Price of Hamburgers2001 $1 $22002 $2 $3

Step 3. Compute the basket cost for each year.2001 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $82002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $14

Step 4. Choose one year as a base year (2001) and compute the CPI2001 ($8/$8) x 100 = 1002002 (14/$8) x 100 = 175

Step 5. Use the CPI to compute the inflation rate from previous year

2002 (175/100 x 100 = 175%) or to get actual % (175-100)/100 x 100 =75%

Figuring CPI


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Q. Suppose that a typical consumer buys the following quantities of thesethree commodities in 2000 and 2001.

Commodity Quantity 2000 perUnit Price 2001 perUnit PriceFood 5 units $6.00 $5.00Clothing 2 units $7.00 $9.00Shelter 3 units $12.00 $19.00

Which of the following can be concluded about the CPI for this individual from2000 to 2001?a. It remained unchanged. c. it decreased by 20%b. It decreased by 25%. d. It increased by 20%e. It increased by 25%.

(Answer)

Year 1 [2000]: [5 food x $6 = $30; 2 clothing x $7 = $14; 3 shelters x $12 = $36,for dollar value of $80. CPI = 100 ($80/$80 x 100 = 100 for 2000)]

Year 2 [2001]: [5 food x $5 = $25; 2 clothing x $9 = $18; 3 shelters x $19 = $57,for value of $100. CPI =125 ($100/$80 x 100 = 125% for 2001)]

So, the CPI increased by 25%.

Figuring CPI for an Individual


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If the value of the CPI equals 120,

what does this mean?

The fixed market basket of goods costs 20%

more than in the base period of time


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1962 Prices v. 2006 Pricesin the United States

Tuition at MIT - $1,500

Starting salary - $6,000[college graduate]

New house for $10-15,000 [2.5times the income of a newcollege graduate]

Coke - 10 cents

Movies - .50

1962 Chevy - $1,500

Tuition at MIT - $32,300 Starting salary - $44,000 [college

[college graduate]

New median house price is$218,000 [5 times the income of

todays college grads]

Coke - 60 cents

Movies - $7

2006 Chevy - $23,000

62 Corvette $2,9952006 Corvette $58,000


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Who is the Richest American Ever?John D. Rockefellers[1839-1937] wealth would be worth$200 billion in todays money, or 4 times that ofBill Gates.

Dollar Figures From Different TimesBabe Ruth made $80,000 in 1931. That wouldbe equivalent to $1 million today.

President Herbert Hooverssalary in 1931was $75,000. That would be equivalentto$900,000 today. George Bush is beingpaid $400,000 a year. President Kennedywas paid $100,000 in 62 [$650,000 today]

Although Rockefeller was worth $200 billion, he could not

watch TV, play video games, surf the internet, or send emailto his grandkids. For most of his life, he could not use AC,travel by car or plane, use a telephone to call friends, or takeadvantage ofantibiotics to prolong &enhance life.

Perhaps the average American today is richer thanthe richest American a century ago.

$80,000=$1 M


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GDP Deflator more broadGDP Deflator includes pricesfor all goods thatwe produce:

1.What householders are buying2.What businesses are buying

3.What the government is buying4.What foreigners are buying[does not include imports because

we dont produce imports]


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GDP Deflator Compared to the CPI

[CPI is normally higher.]


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Who measures inflation?

The Bureau of LaborStatisticsin the U.S

Badan PusatStatistikin Indonesia

UK National Statisticsin United Kingdom


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What are the effects ofunexpected

inflation?

Inflation redistributes income

some people win the ones getting the higher

prices (i.e oil/gas companies)

Some people lose the ones paying thehigher prices (think YOU!)


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Who wins and who loses from

inflation?

Debtors win

Borrowers pay back loans with inflated dollars

(dollars that are worth less) Creditors lose

Lenders are paid back with inflated dollars

(dollars that are worth less)


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More winners and losers

of inflation Those on fixed incomes lose

Income does not keep up with prices - standard of living goesdown.

Exception if fixed income is INDEXED to inflation (CPI)

Savers often lose

If prices rise faster than the rate of interest they are getting fromtheir savings (investment) then they lose purchasing power

Government sometimes wins

Government wins Biggest debtor in the World (Debtors WIN!)

Government loses surplus in savings, increase in salaries andother prices paid

Menu costs of inflation

Individuals and business must allocate resources to keep up withchanging prices increases transaction costs

Inflation and uncertainty Do I spend today, or save? Prices going up or not? What is happening to

my purchasing power? ARRRGGHH!


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The Inflation-GDP-Unemployment

Connection

GDP is calculated by taking the price of agood or service and multiplying it by thequantity of the good or service produced.

Example (assume a one product economy)

Dry Erase Marker (sold this year)

$1.00 (Price of one) X 1,000 produced this year

GDP = $1,000


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Connection

Lets assume next year the price of Dry

Erase Markers is $2.00 each and theeconomy still produces 1,000 markers.

$2.00 X 1,000

GDP = $2,000

Has our GDP grown?

What caused GDP to rise? Is this good?

What should be our main concern?


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Connection

Our main concern should be the growth ofthe production of goods and services(G/S). The implication is that with the

growth of production of G/S more workerswill be needed to produce the G/S, therebyputting people to work and getting closer

to the Economic Goal of Full-employment.


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Connection

Our example tells us that we onlyexperienced a rise in price, not a rise inthe quantity of the good produced.

We had inflation.

To see how we are doing from year to year in

the production of G/S we need to factor outInflation


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Connection

Terms we need to know and understand:

Nominal GDP the GDP calculated in any given yearusing that particular years prices or price level.

Real GDP the GDP calculated for a given year withthe change in price level (Inflation) factored out.Measures the production of G/S in terms of a baseyear price level

GDP Deflator- calculates the change in price level fora particular year compared to an established baseyear price level.

Y P i f Q tit N i l GDP R l GDP


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Year Price ofGoodsandServicesProduced

Quantityof GoodsandServicesProduced

NominalGDP

(unadjustedfor PriceChange)

GDP

Deflator

Real GDP(adjustedfor PriceChange)

1999 .50 1,000

2000 .75 1,000

2001 .75 1,200

2002 1.00 1,100

2003 1.50 1,150

Nominal GDP = Price of G&S x Quantity of G &SGDP Deflator = Current Price/Base Year Price

Real GDP = Nominal GDP/GDP Deflator X 100


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Unemployment Inflation GDP RealGrowth

Rate

Good 6% or less 1% to 4% 2.5% to 5%

Worry 6.5% to 8% 5% to 8% 1% to 2%

Bad 8.5% or more 9% or more .5% or less

What does all this mean???

Unemployment Rate 9.7 % Inflation Rate -2.10% Real GDP -6.0%

IT IS A MUST TO REMEMBER


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IT IS A MUST TO REMEMBERTHIS FORMULA:

Real = Nominal - InflationGDP

Interestrate

GDPInterestrate


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Increased


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inflation and cpi

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