1. Measuring Inflation Measuring Inflation using a Price Index

2. 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%] underUSA speed limit: target for inflation is under 2.5%

3. Deflation Stagflation Low inflation 1985 - 2012 Some factors: Technology & Globalization

4. What is a Price Index? A price index is used by economists to measure inflation –This allows you convert nominal numbers => to real numbers A price index must choose a base year which will = 100 –You use “prices” of goods from this year for all goods & services For AP Econ we will analyze 2 price indices: –Consumer Price Index –GDP Deflator

5. Calculating % Change You buy a stock at $8 per share It is now at $10 per share If a price index rises from 100 to 125? Formula: [(Ending Price – Beginning Price) / Beginning Price] * 100 (10-8)/8 * 100 = +25% What % gain did you make? (125-100)/100 * 100 = +25%

6. CPI Index Consumer Price Index (CPI) measures consumer inflation –You can use any year as a base year (which = 100) Uses a market “basket” of goods & services –Government prices basket monthly –Compares cost of the new basket to old basket CPI = Current Price Value of Basket Price Value of Basket in Base Year X 100 = CPI Index

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

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

9. Worksheet Creating an Index

10. Problems with CPI Substitution Bias New goods Unmeasured quality changes Housing Measurement Basket must “evolve” with the market

11. Adjusting numbers for inflation Convert Babe Ruth’s wages in 1931 to 2005 dollars: 1931 Salary = $ 80,000 CPI = 15.2 1931 CPI = 195 2005 195 15.2 X $80,000 = 1,026,316 (2005 dollars) CPI Index (2005) Base Year Index (1931) X Old Dollar Value = 2005 dollars

12. Practice Test