Download Price level

Price level
Petr Wawrosz
What is price level
• Theoretical concept expressing all prices in
economics
• Aggregate indicators of all prices in economy
• We are not able to measure (to identify) all
prices in economy (prices of all goods, final
and capital goods)
• However we need to know what happens with
prices on the aggregate level.
CPI
• Price level is expressed (measured) by CPI
• Consumer price index
• Basket of selected goods – mostly consumed by
household
• Weight mean of the price
• Weight = the share of spending for one good (in
the basket) on the total amount of the spending
• The indicator without unit of measurement.
Equation of CPI:
• 𝐂𝐏𝐈 =
𝐧
(
(𝐩𝐢,𝟏 /𝐩𝐢,𝟎 ∗ 𝐩𝐢,𝟎 ∗ 𝐪𝐢,𝟎 )/
𝐢=𝟏
•
•
•
•
𝐧
𝐩𝐢,𝟎 ∗ 𝐪𝐢,𝟎
𝐢= 𝟏
Explanation of the symbol:
p = price, q = quantity
1 =symbol for the current period, 0 = symbol for the basic period
i = symbol for specific good (first good e.g. sandwich, second one e.g. beer,
third one e.g. sending sms)
• 𝐩𝐢,𝟏 /𝐩𝐢,𝟎 = change of the price of i good between current and basic period
• 𝐩𝐢,𝟎 ∗ 𝐪𝐢,𝟎 = 𝒘𝒆𝒊𝒈𝒉𝒕 𝒐𝒇 𝒊 𝒈𝒐𝒐𝒅
𝐧
•
𝐢= 𝟏 𝐩𝐢,𝟎 ∗ 𝐪𝐢,𝟎 = sum of the weights of all goods
The problems with CPI
• Stable weight
• No new goods
• No change of quality of the good
Inflation
• = growth of the price level
• = the value of the price level in the next (further)
period is higher than the value of the price level in
former period.
• 𝛑=
𝐏𝐧+𝟏 −𝐏𝐧
𝐏𝐧
=
𝐏𝐧+𝟏
𝐏𝐧
−1
• If we expect that price level is expressed by CPI:
𝐂𝐏𝐈𝐧+𝟏 − 𝐂𝐏𝐈𝐧 𝐂𝐏𝐈𝐧+𝟏
𝛑=
=
−1
𝐂𝐏𝐈𝐧
𝐂𝐏𝐈𝐧
• Inflation is usually measured in percentage (the
equation is multiplied by 100)
Change of inflation
• If price level change about 5 % between period 1
and 2 and also between period 2 and 3, the value
of the inflation become same = stable inflation.
• If price level change about 5 % between period 1
and 2 and e.g. A bout 8 % between period 2 and
3 we speak about acceleration of inflation.
• If price level change about 5 % between period 1
and 2 and e.g. about 2 % between period 2 and 3
we speak about deceleration of inflation or about
disinflation.
• Negative change of price level calls deflation.
Nominal and real interest rate
• i = nominal interest rate (including inflation)
• r = real interest rate (without inflation)
• (1 + i) = (1 + r) * (1 + π)
• 𝐫=
1+𝐢
1+𝛑
−1
• For small value of i, r, π it is valid:
r ≈ i – π, ≈ symbol for approximate equity
The main reason of inflation
• The growth of the amount of the money in
economy.
• The amount of money grows quickly (higher)
than amount of produced goods.
• If amount of goods and amount of money growth
in same rate -> usually no inflation.
• Attention! V = velocity of money: how often the
unit of money is used in defined period of time
If V changes (increases) than situation of same
growth rate of money and goods leads to
inflation.
The consequences of inflation
The loss of purchasing power of
money
• Money loses its value.
• The purchasing power of money is the volume of
things that we can buy for a unit of money.
• Purchasing power of money is the inverse function of
the price level.
• 𝑃𝑃 =
1
𝑃
• 1 + 𝑃𝑃 =
• or
• 𝑃𝑃 =
1
1+π
1
1+ π
−1
Menu cost
• = cost connecting with necessity of changing price
• = prices do not fulfill their role (inflations distorts the
information delivered by prices) to inform about
relative scarcity and utility of each good or factor of
production in comparison with other good or factor of
production
• Inefficient allocation
• Confusion and inconvenience
• People bears (takes) higher risk.
• Shoelaether costs
Redistribution of wealth
• In favor of people who anticipate the right
level of inflation and not in favor of people
who do not anticipate the right level.
• Anticipated and anticipated inflation
• Adaptive and rational expectations
Tax distortion
• Taxes on nominal measurement.
• Examples:
- progressive taxes on income
- taxes on nominal income
Deflation
• Credit-freeze
• In deflation people are not willing to borrow
money – they face high real interest rate and the
are not able to pay the interests.
-> reduction of investments, shrink of capital
goods, negative impact on production.
• People postpone their purchases – they are
waiting for another fall of prices -> firms reduce
their production.
The best solution?
• Small positive inflation (about 2 % p.a.)
• People are forced to care about their money.
• If one firms is in trouble it does not increase
wages of its employee.
• No-increase of wages in the situation of small
inflation is more acceptable than shrink of
wages.