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Economics Indicators
INFLATION & THE
CONSUMER PRICE INDEX (CPI)
What is Inflation?
Inflation
• A significant rise in prices and costs that
results in the decline in the purchasing
power of a currency.
• An increase in the price of just one good or
service is not inflation.
• Economists have identified two main forms
of inflation: Cost Push & Demand Pull
Inflation.
Demand Pull Inflation
• If there is an increase in demand from
households, firms, government,
aggregate demand (total demand) can be
forced upwards and the price level pulled
up accordingly.
• High levels of consumer demand may
occur when employment is strong (low
unemployment) and incomes are rising.
Cost Push Inflation
• An across the board increase in
producers costs of production can cause
cost push inflation.
• What would cause cost-push inflation??
eg. Wage rises, a rise in the price of
imported oil (transport companies) and
an increase in interest rates
• Labour costs usually represent the largest
component of production costs and can
contribute significantly to inflationary
pressures during a boom period.
What level of inflation is acceptable for
a developed country?
• At first, it would be desirable to want a very low rate of
inflation for a country.
• However, very low rates of inflation (less than 1%)
indicate low levels of economic demand and low GDP
growth.
• An inflation rate of 2 to 3% is considered desirable for
most developed economies as a sign of a healthy
economy. However, there are exceptions like Japan.
• An inflation rate of 5% or more for a developed country
is generally too high and it would be a sign of an
overheating (growing too fast) economy – cost push
inflation would be a problem.
What level of inflation is acceptable for
a developing country?
• A developing country, may have a higher inflation
rate than a developed country, because price
stability may be less important than economic
growth.
• An inflation rate of 5 to 10% may be acceptable, if
high (GDP) growth is being achieved.
• However, if inflation is between 5 to 10% and
economic growth is relatively low, then policy
makers are failing to achieve the most optimum
use of resources.
Inflation - Exercise
• Go to www.economist.com
• Click on economics, and then market & data, and then
output, jobs etc.
1. List three countries with the highest inflation rate in
the developed world.
2. List three countries with the highest inflation rate in
the developing world?
3. A inflation rate of between 2 to 3% is considered a
healthy range for a developed economy with
moderate growth rates. How many countries are in
this category?
HOW TO MEASURE INFLATION:
PRICE INDICES
Price Indices
• The main function of a price index is
to give a generalized and simplified
view of price changes by
summarizing in one figure, the
general movements in prices of a
number of a number of
commodities.
HOW TO MEASURE INFLATION:
COMPILING A PRICE INDEX
Selection of a Regimen
• The regimen is the group or basket of
commodities whose price changes are to be
summarized in the price index.
Collection of Accurate Prices
HOW TO MEASURE INFLATION:
COMPILING A PRICE INDEX
Selection of a Base Year or Period
• It is necessary to select a period as a standard
with which prices in other periods can be
compared.
• This should be a normal period (not a war
period or period of high inflation or a
recession).
• The aggregate expenditure on the regimen in
the base period is denoted by the index
number 100.
• The index number for the following years is
then expressed as percentage.
HOW TO MEASURE INFLATION:
COMPILING A PRICE INDEX
Weighting the Items
• This is an attempt to assess the relative
importance of expenditure of items included
in the regimen.
• Eg. Milk would be given greater weighting
than Jeans, because it is purchased more
often and is more important to the majority of
the population.
• In creating a indice, weight can simply return
to the frequency of purchase.
HOW TO MEASURE INFLATION
PRICE INDICE - EXAMPLE
Product
Weight
Price
2007
Expenditure Price
2007
2008
Quiksilver
1
Boardshorts
$49
49
$55
55
Pauls
Milk 2 Litre
30
$3.10
93
$3.25
97.5
Top 10 CD
(Target)
3
$20.50
61.5
$21.15
63.45
Train Ticket
(Metrorail)
20
$3.95
79
$4.05
81
282.5
TASK: Using the above information calculate the inflation rate for 2008
Expenditure
2008
296.95
HOW TO MEASURE INFLATION
PRICE INDICE - EXERCISES
Formula CPI = (296.95/282.5) x 100
= 5.12%
New weighted Total Price
Old Weighted Total Price
x 100
What is the inflation rate in the island
nation of Isla Bonita?
Product
Weight
Price
2012
Expenditure Price
2012
2013
Swimming
Suit
1
$35
$40
1 Litre
Orange
Juice
25
$1.25
$1.35
1 Bus
Ticket
15
$2.25
$2.30
Rent
(average
apartment)
1
10000
11000
Expenditure
2013
TASK: Using the above information calculate the inflation rate at end of 2013
The Consumer Price Index (CPI)
A Key Economic Indicator
• Most countries in the world publish a CPI which is a key
economic indicator.
• The consumer price index is sophisticated price indice.
• Date is published monthly.
• The CPI includes a range of goods and services.
• This includes the cost to rent average home, the price
of bus tickets, and a range of food and beverages.
• Housing has the strongest weighting in most CPI
calculations.
• In many countries, the CPI also includes items such as
tobacco, which some economists believe should be
excluded.
Deflation
• During periods of economic contraction (negative
GDP), an economy may experience deflation –
prices on average start falling.
• Alternatively, a country may have positive GDP
growth generated by exports sales, but still have
very low levels of demand in the domestic
economy. This low level of demand in the
domestic economy will force prices down. This is
the problem in Japan.
• Japan has suffered from several periods of
deflation in the last 15 years.
THE UNDERLYING
INFLATION RATE
• Instead of just quoting the standard or headline CPI
figure, some economists cite the underlying CPI rate,
as a more accurate reflection of price changes.
• The underlying CPI rate is an attempt to identify the
price changes resulting from real demand and supply
forces at work in the domestic economy and not
price changes caused by temporary institutional or
external (international) factors.
• The underlying CPI measure excludes seasonal
factors, petrol prices and government and financial
charges which are included in the headline rate.
The GDP Deflator
• An alternative measure of inflation.
• The GDP deflator provides the broadest coverage of
price changes than the CPI.
• As GDP includes all components of national output,
the deflator combines the price movements of all
sectors of the economy (producer, wholesale, retail),
whereas CPI shows only price changes at the retail
level.
• Changes in the cost of providing some government
services like defence and education are included in
the GDP deflator.
Problems with the
GDP Deflator
• It can be influenced by fluctuation in export
prices. Export prices might be increasing, but
domestic prices remain unchanged.
• There is an increased time delay between the
release of GDP statistics.
• CPI figures available some months ahead of
GDP statistics.
Inflationary Expectations
• Economic decision makers, such as wage
earners, borrowers and lenders will need to
take account of the expected inflation rate
when negotiating some deals.
• Wages increases must at least be above the
inflation rate, to maintain purchasing power.