Economic Indicators INFLATION & THE CONSUMER PRICE INDEX (CPI)

Recap: The 4 main macroeconomic objectives ECONOMIC GROWTH FULL EMPLOYMENT (LOW UNEMPLOYMENT) LOW & STABLE RATE OF INFLATION (IMPROVED) EQUITY IN THE DISTRIBUTION OF INCOME HOW ARE EACH OF THESE MEASURED???

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:

INFLATION What is a dollar worth? – 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 – –Using the info, when did inflation, disinflation, and deflation occur?

CPI v. GDP Deflator CPI –Smaller: Only samples of retail (consumers) –Includes imports (if in the ‘basket’) –Prob: Not all consumers buy the same things…Think about baskets for: A family w/kids A single adult An elderly couple GDP Deflator –Broader: total economy, not just “C” –Does not include imports –Prob: Slower to compile than CPI (time delay) But both measure inflation and are calculated using a base year!

What goes into the CPI? 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? DEMAND -PULL COST- PUSH QUANTITY THEORY

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 14 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

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 (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 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 - EXAMPLEProductWeightPrice2007Expenditure2007Price2008Expenditure2008 QuiksilverBoardshorts1$4949$5555 Pauls Milk 2 Litre 30$3.1093$ Top 10 CD (Target)3$ $ Train Ticket (Metrorail)20$3.9579$ TASK: Using the above information calculate the inflation rate for 2008

HOW TO MEASURE INFLATION PRICE INDICE - EXERCISES Formula CPI = (296.95/282.5) x 100 = 5.12% New weighted Total Price x 100 Old Weighted Total Price

What is the inflation rate in the island nation of Isla Bonita?ProductWeightPrice2012Expenditure2012Price2013Expenditure2013 SwimmingSuit1$35$40 1 Litre Orange Juice 25$1.25$ Bus Ticket15$2.25$2.30 Rent (average apartment) 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.