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Economic Indicators INFLATION & THE CONSUMER PRICE INDEX (CPI) Recap: The 4 main macroeconomic objectives ECONOMIC GROWTH FULL EMPLOYMENT (LOW UNEMPLOYMENT) HOW ARE EACH OF THESE MEASURED??? LOW & STABLE RATE OF INFLATION (IMPROVED) EQUITY IN THE DISTRIBUTION OF INCOME INFLATION key definitions • INFLATION •An increase in the general price level over time that results in a decrease in the purchasing power of a currency • DEFLATION •A decrease in the general price level over time • DISINFLATION •A decrease in the rate of inflation • CPI (CONSUMER PRICE INDEX) •A basket of goods and services consumed by the average household whose prices can be measured over time Video: http://www.investopedia.com/video/play/what-is-the-consumer-price-index-cpi/ INFLATION • What is a dollar worth? – http://www.usinflationcalculator.com/ • What is purchasing power? – The value of a particular monetary unit in terms of the goods or services that can be purchased with it. • US Consumer Price Index, 1913-present – http://www.minneapolisfed.org/community_education/teacher/calc/hist1913.cfm – Using the info, when did inflation, disinflation, and deflation occur? CPI v. GDP Deflator • CPI • GDP Deflator – Smaller: Only looks @ samples of retail (consumers) – Includes imports (if in the ‘basket’) – Prob: Not all consumers buy the same things…Think about baskets for: – Broader: Looks @ total economy, not just “C” – Does not include imports – Prob: Slower to compile than CPI (time delay) • A family w/kids • A single adult • An elderly couple But both measure inflation and are calculated using a base year! What goes into the CPI? http://www.bls.gov/dolfaq/bls_ques3.htm Housing is the biggest expense! (How much would the house rent for? Not how much does it cost to buy) What goes into the CPI? Not everything stays! • 2014 : NZ removed envelopes & dictionaries removed in NZ • 2010: England added lip gloss & removed lipstick Other ways to measure inflation • FOCUSING ON “CORE” RATE OF CPI – B/c food & oil prices may fluctuate so much, economists often eliminate them from CPI • PRODUCER PRICE INDEX – Measures changes in the prices of factors of production. *Can help in predicting future inflation WHY DOES INFLATION OCCUR? • QUANTITY THEORY • DEMAND • COST-PULL PUSH Who benefits from inflation? Who is hurt by inflation? Let’s find out in the “Inflation: Types & Effects” contest! Can inflation occur only for certain goods and services and not others? • Let’s take a look... 11 Is this showing nominal or real increases in prices? What explains the higher cost of education/medical care? Note: A rise in the cost of one type of good DOES NOT equal inflation! Negative Consequences of Inflation/Deflation • possible negatives of inflation? • greater uncertainty • redistributive effects • less saving • damage to export competitiveness • Menu costs • possible negatives of deflation? • high levels of cyclical unemployment • bankruptcies 14 Redistributive Effects of (Unanticipated) Inflation • Losers • Fixed income/wages (or wages that don’t increase as fast) • Holders of cash • Savers (w/o interest) • Lenders (creditors) 15 ANOTHER PROBLEM WITH UNANTICIPATED INFLATION • Since purchasing power is decreasing, people may spend more now. – Would this lead to more or less inflation? 16 DEFLATION • The “deflationary spiral” JAPAN & DEFLATION FINALLY...WHY IS DEFLATION BAD? • ***don’t forget--cyclical unemployment & bankruptcies*** • 3 Reasons from Paul Krugman – (demand side)–people put off spending/spend less http://krugman.blogs.nytimes.com/2010/08/02/why-is-deflation-bad/) (in other words…they are less willing to borrow) • *sitting on cash becomes a positive investment • *borrowers must repay in $$$ worth more than what they borrowed – (demand side) - increases real burden of debts • debtors cut spending when debt rises • Also…consumers postpone purchases (Why?) • creditors don’t increase spending by same amount – (supply side) - downward nominal wage rigidity • in simple terms...wages rarely fall unless they are accompanied by mass unemployment 19 SO…IF DEFLATION IS BAD & TOO MUCH INFLATION IS BAD, THEN WHAT IS ACCEPTABLE? 2%-3% in developed countries A little higher in developing countries (if the economy is growing!) 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? Extra: ‘Fun Facts’ about how price indices are formed 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. • Data 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.