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 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 - 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. 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.