1. Chapter 2 General Price Level
Economics
Chapter 2
General Price Level

2. General Price Level General price level Price index
Weighted average of prices of all goods and services.
Shown by different price indexes
Price index
A figure showing the price level of the same basket of goods and services.
Base period vs. specific period
At base year, always set at 100

3. Consumer Price Index (CPI)
Price level of goods and services generally consumed by household.
Index
Expenditure range
% of household
Price change faced by income group
CPI (A)
$4,000-$15,499
50%
Low
CPI (B)
$15,500-$27,499
30%
Medium
CPI (C)
$27,500-$59,999
10%
High
Composite CPI
$4,000-$59,999
90%
App. all household

4. Consumer Price Index (CPI)
HK Statistics: Base year =
Source: Table: Consumer Price Indices, Census and Statistics Department, Hong Kong (
Year / Month
Composite CPI
CPI (A)
CPI (B)
CPI (C)
2005 annual
100
2009 annual
109.5
107.4
110.0
110.9
2010 annual
112.1
110.4
112.7
113.2
2011 (Mar)
116.8
116.4
117.0
116.7
2011 (Jun)
118.9
118.2
119.1
119.2
2011(Sept)
117.9
113.8
119.3
120.7

5. Calculate CPI CPI of 2000 = $𝟏,𝟎𝟎𝟎 $𝟏,𝟎𝟎𝟎 𝑿𝟏𝟎𝟎=𝟏𝟎𝟎
Year 2000
Year 2008
Year / Month
Selling Price
Expenditure
40 Shirts
$10
$400
$12
$480
30 loaves of bread
$20
$600
$30
$900
Total
$1,000
$1,380
CPI of 2000 = $𝟏,𝟎𝟎𝟎 $𝟏,𝟎𝟎𝟎 𝑿𝟏𝟎𝟎=𝟏𝟎𝟎
CPI of 2008 = $𝟏,𝟑𝟖𝟎 $𝟏,𝟎𝟎𝟎 𝑿𝟏𝟎𝟎=𝟏𝟑𝟖

6. Example
Year 2009 (base year)
2010
2011
Price
Exp.
20 T-Shirts
$20
$400
$25
$500
$50
$1000
40 apples
$2.5
$100 $4
$160
$10
Total
$660
$1400
CPI of 2009 = $𝟓𝟎𝟎 $𝟓𝟎𝟎 𝑿𝟏𝟎𝟎=𝟏𝟎𝟎
CPI of 2010 = $𝟔𝟔𝟎 $𝟓𝟎𝟎 𝑿𝟏𝟎𝟎=𝟏𝟑𝟐
CPI of 2011 = $𝟏,𝟒𝟎𝟎 $𝟓𝟎𝟎 𝑿𝟏𝟎𝟎=𝟐𝟖𝟎

7. The implicit price deflator of GDP
Also named as : GDP deflator
Measure the price change of all types of goods included in GDP.
Formula:
𝑰𝒎𝒑𝒍𝒊𝒄𝒊𝒕 𝒑𝒓𝒊𝒄𝒆 𝒅𝒆𝒇𝒍𝒂𝒕𝒐𝒓 𝒐𝒇 𝑮𝑫𝑷= 𝑵𝒐𝒎𝒊𝒂𝒏𝒍 𝑮𝑫𝑷 𝑹𝒆𝒂𝒍 𝑮𝑫𝑷 𝒙 𝟏𝟎𝟎

8. The implicit price deflator of GDP
Year
Nominal GDP ($)
Real GDP ($)
GDP deflator
2009
(base yr.)
1,000
𝑥 100=100
2010
1,200
𝑥 100=120
2011
1,600
1,350
𝑥 100=160

9. Coverage CPI GDP deflator Products consumed by household
Fixed basket of goods and services. (Same for diff. yrs)
Imports , Exports 
Capital goods 
GDP deflator
All products produced by an economy
Counting all GDP components: C + I + G + X - M.
Exports , imports 
Capital goods (I) 

10. Inflation
Definition: The persistent increase in the general price level.
Shown by CPI  continuously.
Hong Kong Statistics:
Inflation rate = 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒚𝒆𝒂𝒓 − 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝒑𝒓𝒆𝒗𝒊𝒐𝒖𝒔 𝒚𝒆𝒂𝒓 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝒑𝒓𝒆𝒗𝒊𝒐𝒖𝒔 𝒚𝒆𝒂𝒓 𝒙 𝟏𝟎𝟎%
Inflation rate = 𝑪𝑷𝑰 𝒐𝒇 𝟐𝟎𝟏𝟏 −𝑪𝑷𝑰 𝒑𝒇 𝟐𝟎𝟏𝟎 𝑪𝑷𝑰 𝒐𝒇 𝟐𝟎𝟏𝟎 𝒙 𝟏𝟎𝟎%
Inflation rate = 𝟏𝟎𝟓.𝟔 −𝟏𝟎𝟎 𝟏𝟎𝟎 𝒙 𝟏𝟎𝟎%=𝟓.𝟔%

11. Deflation Definition:
The persistent decrease in the general price level.
Inflation rate is negative

12. Inflation Given the CPIs of Economy A Find the inflation rate in 2009.
Year
CPI
2008 (Base year)
100
2009
110
2010
125

13. CPI vs. GDP deflator Aim at CPI GDP deflator
Change in the cost of living
Amount spent on basic living expenses
GDP deflator
Purchasing power of money
Amount of goods that can be bought with money

14. Purchasing power In 2009 A hamburger = $10
i.e. You can buy a hamburger if you have a $10 note
In 2010
A hamburger = $12
i.e. You can’t buy a hamburger with a $10 note
The purchasing power of the $10 note is lowered
Nowadays, the 10 cents coins have very little purchasing power

15. CPI - Overestimation Substitution bias: CPI  Basket (Good A)
If Price of Good A  Choose Good B (substitute)
Although CPI (Good A), people are not fully affected
Same living standard
CPI overestimate the increase in price level

16. CPI - Overestimation Quality improvement:
Products with high technology (e.g. new mobile phone)
Buy same amount (same expense)  better enjoy or
Buy the same old model (less expense)  same enjoy
CPI can’t reflect the change in enjoyment

17. Which price index is better? (Textbook p.60-61)
Year
Implicit price deflator of GDP
Inflation rate
Composite CPI
2003
104 -
99.8
2004
100.3
- 3.6%
99.4
- 0.4%
2005 0%
0.9%
a. Calculate the inflation rates of 2004 and 2005.
Inflation rate of 2004 = 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝟐𝟎𝟎𝟒 − 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝟐𝟎𝟎𝟑 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝟐𝟎𝟎𝟑 𝒙 𝟏𝟎𝟎%
Inflation rate of 2005 = 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝟐𝟎𝟎𝟓 − 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝟐𝟎𝟎𝟒 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝟐𝟎𝟎𝟒 𝒙 𝟏𝟎𝟎%

18. Which price index is better? (Textbook p.60-61)
Year
Implicit price deflator of GDP
Inflation rate
Composite CPI
2003
104 -
99.8
2004
100.3
- 3.6%
99.4
- 0.4%
2005 0%
0.9%
b. Describe the changes in inflation rates and cost of living with reference to the GDP deflator and Composite CPI.
Base on GDP deflator:
a ______ inflation rate in 2004 suggests a ________ in the cost of living.
a ______ inflation rate in 2005 showing that the cost of living __________________.
Base of Composite CPI:
a ______ inflation rate in 2005 suggests a ________ in the cost of living.
negative
decrease
zero
remains unchanged
negative
decrease
positve
increase

19. Which price index is better? (Textbook p.60-61)
Year
Implicit price deflator of GDP
Inflation rate
Composite CPI
2003
104 -
99.8
2004
100.3
- 3.6%
99.4
- 0.4%
2005 0%
0.9%
c. Which index is a better indicator of inflation? Which index is a better indicator of the cost of living?
Inflation refers to ___________________________________________
As the ______________ measure price changes of a large scope of goods, it is better indicator of inflation
Cost of living refers to ___________________________________________
It is affected by price change in _________ goods only.
Therefore, ________ , which includes only _________ goods, is a better indicator of the cost of living.
A persistent increase in the general price level
GDP deflator
amount spent on basic living expenses
consumer
CPI
consumer

20. Which index is better? GDP deflator CPI
Prices change of a large scope of goods
Better for measuring inflation
CPI
Price change of consumer goods
Better for indicating living standard