Download Measuring Inflation

Measuring Inflation
Measuring Inflation using a Price Index
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%
Some factors: Technology & Globalization
Stagflation
Low inflation
1985 - 2012
Deflation
What is a Price Index?
• A price index is used by economists to measure inflation
– This allows you convert nominal numbers => to real numbers
• A price index must choose a base year which will = 100
– You use “prices” of goods from this year for all goods & services
• For AP Econ we will analyze 2 price indices:
– Consumer Price Index
– GDP Deflator
Calculating % Change
• You buy a stock at $8 per share
What % gain did you make?
• It is now at $10 per share
• If a price index rises from 100 to 125?
Formula:
[(Ending Price – Beginning Price) / Beginning Price] * 100
(10-8)/8 * 100 = +25%
(125-100)/100 * 100 = +25%
CPI Index
• Consumer Price Index (CPI) measures consumer inflation
– You can use any year as a base year (which = 100)
• Uses a market “basket” of goods & services
– Government prices basket monthly
– Compares cost of the new basket to old basket
• CPI
=
Current Price Value of Basket
X 100
Price Value of Basket in Base Year
= CPI Index
What is in the CPI’s Basket?
17%
Transportation
15%
Food and
beverages
Education and
communication
42%
Housing
6%
6%
6% 4% 4%
Medical care
Recreation
Apparel
Other goods
and services
CPI Index Calculation
Price Value of Basket
Use 2005 as base year
2005
2007
CPI Index =
$10/$10 X 100 = 100
$10
$12
120 is the
CPI Index for
2007
($12/$10) X 100 = 120
End Result:
Current Price Value of Basket
X 100
Price Value of Basket in Base Year
= CPI Index
Inflation rose 20%
(120 – 100)/100 X 100 = +20%
Worksheet
• Creating an Index
Problems with CPI
•
•
•
•
Substitution Bias
New goods
Unmeasured quality changes
Housing Measurement
Basket must “evolve”
with the market
Adjusting numbers for inflation
• Convert Babe Ruth’s wages in 1931 to 2005 dollars:
CPI Index
(2005)
Base Year Index
(1931)
1931 Salary = $ 80,000
195
15.2
X Old Dollar Value = 2005 dollars
CPI = 15.2
1931
CPI = 195
2005
X $80,000 = 1,026,316 (2005 dollars)
Practice Test