Download consumer price index

Chapter 21
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Inflation
Inflation is defined as a steady and persistent
increase in the general level of prices. It’s the
rate at which your money loses its ability to
buy things.
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Measuring Inflation
Simple price index:
Price in any year
Price in base year x 100
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Five Steps to Create a
Composite Price Index
 Choose a base year and let all the prices equal 100.
 Select the goods and find the prices for all goods in
all years.
 Construct a simple price index for each good.
 Multiply the simple price index by the weight
(proportion of income spent on the good).
 Add to get the composite price index for the
current year.
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Consumer Price Index (CPI)
The consumer price index is the official
measure of inflation in Ireland. It measures the
price changes of goods and services typically
consumed by all consumers living in rural/urban
areas, high-/low-income earners and from all age
groups. It is a price index that shows the current
cost of purchasing the same identical basket of
goods with the base year (starting point).
© Edco 2012. Positive Economics
What are the Economic Uses of
the Consumer Price Index?
 Measures the rate of inflation
 International comparisons
 Indicator of the country’s/government’s
performance
 Indexation of savings and investments
 Used in wage negotiations
 Used by government to index tax bands
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What Precautions Should be
Taken When Using the CPI?
 An index of the average consumer
 Not a cost of living index
 Lags behind consumer trends and fashions
 Static weights
 Quality changes in products
 Substitution of products
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What Factors Cause Inflation?
 Demand pull factors
 Cost push factors
 Imported inflation
 Government-induced inflation
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What Remedies are Available?
 Fiscal policy
 Monetary policy
 Partnership agreements
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What Problems are Caused by
High Inflation?
 Lower standard of living
 Speculation is encouraged
 Borrowing is encouraged
 Wage demands
 Loss of international competitiveness
 Saving is discouraged
 Difficulty attracting foreign direct investment
 Increase in unemployment
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Deflation
Deflation happens when there is a general
decrease in the average level of prices. This
sounds great, but it can damage an economy. If
all prices are steadily declining, then consumers
may postpone buying goods and services,
expecting it to cost less a week later and less
again a month later, causing consumer demand to
fall and thus affecting employment and growth
(e.g. house prices at present in Ireland). Likewise,
a company might postpone investing and the
economy would suffer.
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Benefits of Price Stability
 Consumers will tend to spend, generating demand for
goods and services and hence employment,
contributing to economic growth.
 The demand for wage increases won’t be as urgent
given that workers’ purchasing power isn’t falling. This
in turn keeps costs stable and companies may decide
to increase investment given that they are able to
plan more effectively.
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Benefits of Price Stability cont.
 Old-age pensioners and those on fixed pensions
will see their purchasing power being maintained
and will be able to manage better.
 Savings in the economy may increase, leading to
investment (if the rate of inflation is less than the
rate of interest).
 Government revenues could increase with more
indirect and direct taxes being collected due to
increased numbers of people working and
spending.
© Edco 2012. Positive Economics
Constant Tax Price Index
The constant tax price index is a price index
that keeps the indirect tax part of a price increase
constant. The main use of this index is in wage
negotiations. It will reduce the possibility of
employees getting wage increases to compensate
for increases in taxation.
© Edco 2012. Positive Economics