2. 2
Inflation
Inflation may be defined as a persistent
and appreciable rise in the general
level of prices.
In reality, any rise in prices is classed
as inflation.
3. Inflation Key Points
Rise in the general level of prices
Persistent
Appreciable
Inflation reduces the purchasing power of Yd
4. 4
Measuring Inflation
Inflation is measured by indexes which determine changes in the
price level.
The indexes compare current prices with prices of an earlier
period called the base period.
The base (first) period is given a value of 100 and the prices of
subsequent periods are compared against the base year.
5. 5
Measuring Inflation
The most common measure of
inflation is the Consumer Price
Index (CPI).
The prices of a large variety of
goods and services (known as a
‘basket’) are monitored on a
quarterly basis.
6. 6
Measuring Inflation
For example, if the price of the basket had increased 15%
since the base year, the CPI would read 115, if the price
had fallen by 15% since the base year the CPI would be
85.
7. 7
Measuring Inflation
It is important to remember that the CPI
measures price movements and not
actual price levels.
8. 8
Measuring Inflation
For example, if the index for
beer is 108 and the
corresponding index for wine
during the same period is
104 it doesn’t mean that the
price of beer. Is more
expensive than wine.
u It means that the price of beer has
increased twice as much as that of wine
since the base year.
9. 9
Measuring Inflation
Compilation of the CPI involves a quarterly survey
of a ‘basket’ of goods and services representing a
high proportion of household expenditure.
10. 10
Measuring Inflation
The basket of goods and services upon which
the CPI is based is referred to as a regimen
and is divided into 11 groups.
11. The CPI Structure
The 11 groups are:
Food
Alcohol and tobacco
Clothing and footwear
Housing
Household contents and services
Health
Transportation
Communication
Recreation
Education
Financial and insurance services
12. The CPI Structure (cont'd)
CPI Group weightings, across 8 capital cities.
13. 13
Measuring Inflation
The CPI is a weighted index. Weights are allocated to categories of
spending to reflect the proportion of total expenditure on those
items.
e.g. if cleaning products make up 3% of expenditure, it accounts
for 3 out of 100 weights.
14. 14
Constructing the CPI Index
Period 1 Period 2
Commodity Weight Price WXP Price WXP
Food 40 0.65 26 0.80 32
Clothing 30 0.70 21 0.80 24
Housing 20 1.15 23 1.15 23
Recreation 10 1.00 10 1.10 11
Total 100 80 90
Price Index 100 112.50
15. 15
Measuring Inflation
In order to find the annual rate of inflation, the following
formula applies:
Annual rate CPI (year 2) – CPI (year 1)
of inflation CPI (year 1)
x 100
Therefore
90 (Year 2) – 80 (Year 1)
x 100 = 112.5
80 (Year 1)
16. Measurement cont….
Calculate the following: 1990 CPI = 105
2000 CPI = 126
Inf% for the decade = [(126 - 105) ÷ 105] x 100
= (21 ÷ 105) x 100
= 20%
17. The consumer price index is calculated from prices of a ‘basket
of products’. This basket includes
A. all goods and services.
B. a sample of non-final goods and services.
C. a few retail goods and services.
D. a sample of all goods and services.
Answer = D
