MEASURING INFLATION

AND DEFLATION
For dummies

THE CONSUMER PRICE

INDEX

Straight from IB GUIDE:

*Explain that inflation and deflation are typically
measured by calculating a consumer price index
(CPI), which measures the change in prices of a
basket of goods and serviced consumed by the
average household

 Price index: measure of average

prices in one period relative to
average prices in reference period
called a base period
One of the most commonly used
price indices to measure inflation is
CPI

CPI-what is it, how its

constructed
CPI is a measure of the cost of living, or the cost
of goods and services purchased by the typical
household in an economy.
Its constructed by a statistical service in each
country: it creates a hypothetical basket of
goods that are consumed by a typical household
during the year (price x quantity=total value of
basket). Then the value of the same basket is
calculated for subsequent years. CPI shows how
the value of the basket changes from year to
year by comparing its value with the base year.

SUMMING UP
The consumer price index (CPI) is a measure
of the cost of living for the typical household
and compares the value of a basket of goods
and services in one year with the value of the
same basket in a base year. Inflation( and
deflation) are measured as a percentage
change in the value of the basket from one
year to another. A positive percentage
change indicates inflation. A negative
percentage change indicates deflation.

PROBLEMS WITH CPI

*Explain that different income earners may

experience a different rate of inflation when
their pattern of consumption is not
accurately reflected by CPI
*Explain that inflation figures may not
accurately reflect changes in consumption
patters and the quality of the products
purchased

,,Typical basket problems

 Different rates of
inflation for different
income earners

 Different rates of
inflation depending
on regional or cultural
factors

 Changes in
consumption patters
due to consumer
substitutions when
relative price changes

 Changes in
consumption patterns
due to increasing use
of discount stores and
sales.

 Changes in
consumption patterns
due to introduction of
new products

 Changes in product
quality

 International
comparisons

 Comparability
over time

THE CORE RATE OF

INFLATION

*Explain that economists measure a

core/underlying rate of inflation to eliminate the
effect of sudden swings in the prices of food and oil

Highly volatile prices may

give rise to misleading
interpretation about inflation.
SOLUTION: Dont include
products with highly volatile
prices in CPI (products such
as food and energy)

THE PRODUCER PRICE

INDEX

*Explain that a producer price index measuring

changes in the prices of factors of production may
be useful in predicting future inflation.

Producer price index (PPI)- several

indices of prices received by producers
of goods at various stages in the
production process for example:
- PPI for inputs
- PPI for intermediate goods
- PPI for final goods
PPI measures price level changes from
the point of view of producer rather
than consumers.

NOW U KNOW ALL ABOUT

MEASURING THE RATE OF
INFLATION AND DEFLATION.
*magic*