 Inflation (Definition & Measurement) By: Haodi Zhang

Definition  “An increase in the average price level of goods and services In a nation over time.“  Economics Textbook p. 300

What does inflation cause?  Average price level of goods increase  Value of money decreases  People spend now rather than saving

CPI (consumer price index)  Average price of goods and services purchased by households and firms within a region or nation in a given time period  Surveys are conducted by government on hundreds or thousands of goods  CPI = (Basket of Goods P 1 ÷Basket of Goods P B )×100

 CPI J = (1300÷1300)×100 = 100  CPI F = (1360÷1300)×100 = 105  CPI M = (1310÷1300)×100 = 101 Table 1: Calculating a Price Index Good or servicePrice in January/¥Price in February/¥Price in March/¥ Gum Curry Beef Total basket price Example of Calculation

Weighing of Categories in CPI  Different goods have different weights  Weight is in percentages  To ensure that a fluctuation in the price of one category of good does not cause the CPI to fluctuate greatly  Total percentages add up to be 100%  Weighted Price = average price ×weight

Table 2: Establishing a Simple Weighted Price Index Good or service Price in January/¥ Price in February/¥ Price in March/¥ Percentage of income spent on each good (weight)/% Gum Curry Beef Example of Calculation January  WP G = 100×0.15 = 15  WP C = 500×0.60 = 300  WP B = 700×0.25 = 175 Total Weighted Price  = 490 Price Index  (490÷490)×100 = 100

Table 2: Establishing a Simple Weighted Price Index Good or service Price in January/¥ Price in February/¥ Price in March/¥ Percentage of income spent on each good (weight)/% Gum Curry Beef Example of Calculation February  WP G = 110×0.15 = 17  WP C = 450×0.60 = 270  WP B = 800×0.25 = 200 Total Weighted Price  = 487 Price Index  (487÷490)×100 = 99

%ΔCPI Caused By Increase in Price  Equation: %ΔCPI = %ΔPC(weight×0.01)

Example  If the price of curry increases by 20%, how will the inflation be affected?  %ΔCPI = 15(60%×0.01)  %ΔCPI = 9%  If the price of curry increases by 15%, the inflation (CPI) will increase by 9%.

Calculating the Inflation Rate  IR = (CPI 2 – CPI 1 /CPI 1 )×100  IR = (105 – 100/100)×100 = 5%  IR = (101 – 105/105)×100 = –3.8%

Limitations of CPI  Does not reflect the purchases of all consumers  Does not reflect the quality of the products  Does not include prices such as of food and oil  Does not reflect the affect to producers