Measuring Inflation

1. Measuring Inflation Measuring Inflation using a Price Index

2. Historical Inflation • Germany: “hyperinflation” after World War I • Currency became worthless • USA: Late 1970s—Oil Crisis-- 13% inflation • Called “Stagflation” • USA: low inflation since 1985 [2.0-3.0%] • USA speed limit: target for inflation is under 2.5%

3. Some factors:Technology & Globalization Low inflation 1985 - 2012 Deflation Stagflation

4. What is a Price Index? • Aprice index is used by economists to: • measure the inflation rate • convert nominal numbers => to real numbers • A price index will choose a base year (which always = 100) • Use the prices from base year for all goods/services

5. CPI Index • Consumer Price Index (CPI) measures consumer inflation • CPI uses a consumer market “basket” of goods & services • Government prices market basket each month • Compares cost of the new basket to old basket 2011: Market Basket cost $1,000 2012: Market Basket cost $1,100 So inflation = +10.0%

6. 17% Transportation 15% 42% Food and beverages Housing Education and 6% communication 6% 6% 4% 4% Medical care Other goods Recreation Apparel and services What is in the CPI’s Market Basket?

7. Use 2005 as base year CPI Index = $10/$10 X 100 = 100 Current$ Value Basket $ Value Basket in Base Year X100 = CPI Index CPI Index for 2007 ($12/$10) X 100 = 120 CPI Index Calculation Price ($) Value of Basket 2005 $10 • $12 End Result From 2005 => 2007 Inflation rose +20% (120 – 100)/100 X 100 = +20%

8. % Change with Price Index What % gaindid you make? • If a price index rises from 100 to 120? Formula: [(Ending Index – Beginning Index) / Beginning Index] * 100 (120-100)/100 * 100 = +20%

9. Worksheet • Creating an Index