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 the inflation rate convert nominal numbers => to real numbers A price index will choose a base year (which always = 100) Use the prices from base year for all goods/services

CPI Index Consumer Price Index (CPI) measures consumer inflation CPI uses a consumer market “basket” of goods & services Government prices market basket each month Compares cost of the new basket to old basket 2011: Market Basket cost $1,000 2012: Market Basket cost $1,100 So inflation = +10.0%

What is in the CPI’s Market Basket? 17% Transportation 42% Housing 15% Food and beverages 6% Education and communication Medical care 6% Recreation 6% Apparel 4% Other goods and services 4%

CPI Index Calculation X 100 = CPI Index Current $ Value Basket $ Value Basket in Base Year X 100 = CPI Index Price ($) Value of Basket 2005 $10 $12 Use 2005 as base year CPI Index = $10/$10 X 100 = 100 CPI Index for 2007 ($12/$10) X 100 = 120 End Result From 2005 => 2007 Inflation rose +20% (120 – 100)/100 X 100 = +20%

% Change with Price Index If a price index rises from 100 to 120? What % gain did you make? Formula: [(Ending Index – Beginning Index) / Beginning Index] * 100 (120-100)/100 * 100 = +20%

Worksheet Creating an Index