Inflation (Definition & Measurement)

1. Inflation (Definition & Measurement) By: Haodi Zhang

2. Definition • “An increase in the average price level of goods and services In a nation over time.“ • Economics Textbook p. 300

3. What does inflation cause? • Average price level of goods increase • Value of money decreases • People spend now rather than saving

4. CPI (consumer price index) • Average price of goods and services purchased by households and firms within a region or nation in a given time period • Surveys are conducted by government on hundreds or thousands of goods • CPI = (Basket of Goods P1÷Basket of Goods PB)×100

5. Example of Calculation • CPIJ= (1300÷1300)×100 = 100 • CPIF = (1360÷1300)×100 = 105 • CPIM= (1310÷1300)×100 = 101

6. Weighing of Categories in CPI • Different goods have different weights • Weight is in percentages • To ensure that a fluctuation in the price of one category of good does not cause the CPI to fluctuate greatly • Total percentages add up to be 100% • Weighted Price = average price ×weight

7. Example of Calculation January • WPG = 100×0.15 = 15 • WPC = 500×0.60 = 300 • WPB= 700×0.25 = 175 Total Weighted Price • 15 + 300 + 175 = 490 Price Index • (490÷490)×100 = 100

8. Example of Calculation February • WPG = 110×0.15 = 17 • WPC = 450×0.60 = 270 • WPB= 800×0.25 = 200 Total Weighted Price • 17 + 270 + 200 = 487 Price Index • (487÷490)×100 = 99

9. %ΔCPI Caused By Increase in Price • Equation: %ΔCPI = %ΔPC(weight×0.01)

10. Example • If the price of curry increases by 20%, how will the inflation be affected? • %ΔCPI = 15(60%×0.01) • %ΔCPI = 9% • If the price of curry increases by 15%, the inflation (CPI) will increase by 9%.

11. Calculating the Inflation Rate • IR = (CPI2 – CPI1/CPI1)×100 • IR = (105 – 100/100)×100 = 5% • IR = (101 – 105/105)×100 = –3.8%

12. Limitations of CPI • Does not reflect the purchases of all consumers • Does not reflect the quality of the products • Does not include prices such as of food and oil • Does not reflect the affect to producers