Eco 13/2 Correcting Statistics for Inflation

Inflation  GDP can be unreliable because it doesn’t take into account unpaid work or depreciation.  Inflation also skews GDP. Inflation is the prolonged rise in the general price of level of goods and services.

The Purchasing Power of Money  Inflation lowers purchasing power, the real goods and services it can buy. A dollar can’t buy the same amount as it did before. So how does inflation skew GDP?

Inflation and GDP  Last year, an ice cream cone cost $1.00.  Now, it cost $1.50. The same amount of ice cream was produced, it just cost more.

Measures of Inflation  Gov’t measures it in several ways: 1.Consumer price index 2.Producer price index 3.Implicit GDP price deflator

Consumer Price Index (CPI)  Every month the gov’t measures the change in price of a specific group of goods and services that the average household uses.  This “market basket” includes 80,000 specific goods and services under food, housing, transportation, apparel, recreation, medical care, personal care.

CPI  Food  Clothing  Housing  Medical

Base Year  Gov’t compiles the CPI monthly.  Start with a base year (year used as a point of comparison for other years in a series of statistics.  Base year is actually an average between several years and is given the value of 100.

Base Year Ex: Base year For 2001, CPI is Then the average price of goods and services in the market basket has risen 77.1% since See figure 13.5

Producer Price Index (PPI)  PPI is a group of indexes that measures the average change in prices that US producers charge their customers.  The PPI, then, is from the producers’ perspective.

Producer Price Index (PPI)  Most of the producer prices included in the PPI are in mining, manufacturing, and agriculture.

Producer Price Index (PPI)  PPIs usually increase before the CPI. A baker who pays more for ingredients will pass on the added cost to the consumer. So changes in the PPIs are a hint that inflation and CPI will increase.

GDP Price Deflator  This index removes the effects of inflation from GDP so that the overall economy in 1 year can be compared to another year.  When the price deflator is applied to GDP in any year, the new figure is called real GDP.  Real GDP: GDP adjusted for inflation.

GDP Price Deflator  Gov’t uses 1995 as the base year to measure real GDP. Each year the price deflator is used to change current, or nominal GDP into real GDP. Ex: GDP in current dollars for 2002

GDP Price Deflator Ex: GDP in current dollars for 2002 was $10,446.2 billion. To find real GDP for 2002, the gov’t divides 2002 GDP by the 2002 price deflator (110.66) and multiplies the result by 100. $10,446.2/ x 100 = $9,439.9 (in billions) This figure can be compared to 1996 nominal GDP of $7,813.2 billion.