Inflation SFLS CPI

1. Inflation
(Part 1 – Vocab &CPI)

2. 2.) CPI – measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI
Part 1
Part 2
Part 3

3. - a sustained increase in the cost of living or
the general price level leading to a fall in
the purchasing power of money.
Inflation
- is measured by the annual percentage
change in consumer prices.
Rate of
Inflation
***Please remember
that a fall in the
rate of inflation is
not the same thing
as a fall in prices!
1.) Inflation Vocabulary

4. - when the rate of inflation becomes
negative.
Deflation
- the value of money becomes worthless.Hyperinflation
1.) Inflation Vocabulary
Stagflation - persistent high inflation combined with high
unemployment and stagnant demand in a
country's economy.

5. Stagflation was a big problem
in the US and other western
countries in the 1970s

6. It was mostly caused my gas
and raw material prices were
high causing high prices and
high unemployment.

7. 1920’s Germany had this
hyperinflation problem where the
money basically became worthless
caused by a bad economic policy after
losing world war one.

8. {
1946 Hungry Hyperinflation At the height of the
inflation, prices were rising at the rate of 150,000% PER DAY. By
then, the government had stopped collecting taxes altogether
because even a single day’s delay in collecting taxes wiped out the
value of the money the government collected.

9. Zimbabwe
津巴布韦
and its famous inflation
通货膨胀
Also this country…

10. And more recently
similar problems in
this country.

11. 2.) CPI – measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI

12. - measures the typical consumer’s cost of
living with only the typical things that are
purchased.
- the main way to measure inflation.
Consumer Price
Index (CPI)
1.) Inflation Vocabulary

13. How the CPI Is Calculated:
- Government surveys consumers to
determine what’s in the typical consumer’s
“shopping basket.”
2.) CPI – measuring Inflation
1.) Fix the “basket”
- Government then collects data on the
prices of all the goods in the basket.
2.) Find the prices
3.) Compute the
basket’s cost
-Use the prices to
compute the total cost of
the basket.

14. How the CPI Is Calculated:
- The CPI in any year equals:
2.) CPI – measuring Inflation
4.) Choose a base year and compute the index
100 x
cost of basket in current year
cost of basket in base year
- The percentage change in the CPI from the preceding period:
6.) Compute the inflation rate
CPI this year – CPI last year
CPI last year
Inflation
rate
x 100%=
5.) ?

15. CPI basket:
{4 比萨, 10 饺子}
120元 x 4 + 3元 x 10 = 510
110元 x 4 + 2.5元 x 10 = 465
100元 x 4 + 2元 x 10 = 440
cost of basket
3.00元
2.50元
2.00元
price of
饺子
120元2013
110元2012
100元2011
price of
比萨
year
Compute CPI in each year
2011: 100 x (440/440) = 100
2012: 100 x (465/440) = 106
2013: 100 x (510/440) = 116
using 2011 base year:
CPI – example…
x4
x10
Inflation rate:
6%
106– 100
100
x 100%=
9.4%
116– 106
106
x 100%=

16. CPI basket:
{10 kg beer, 20 kg coffee}
The CPI basket cost $1050
in 2009, the base year.
A. Compute the CPI in 2010.
B. What was the CPI inflation rate from 2010-2011?
price of
beer
price of
coffee
2009 $35 $35
2010 $40 $40
2011 $65 $50
CPI – another example…
x10
x20
Questions to try:

17. CPI basket:
{10 kg beer, 20 kg coffee}
The CPI basket cost $1050
in 2009, the base year.
price of
beer
price of
coffee
2009 $35 $35
2010 $40 $40
2011 $65 $50
CPI – another example…
x10
x20
A. Compute the CPI in 2010:
Cost of CPI basket in 2010
= ($40 x 10) + ($40 x 20) = $1200
CPI in 2010 = 100 x ($1200/$1050) = 114

18. CPI basket:
{10 kg beer, 20 kg coffee}
The CPI basket cost $1050
in 2009, the base year.
price of
beer
price of
coffee
2009 $35 $35
2010 $40 $40
2011 $65 $50
CPI – another example…
x10
x20
B. What was the inflation rate from 2010-2011?
Cost of CPI basket in 2011
= ($65 x 10) + ($50 x 20) = $1650
CPI in 2011 = 100 x ($1650/$1050) = 157
CPI inflation rate = (157 – 114)/114 = 38%

19. 2.) CPI – measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI
2.1) Weighting

20. 2.1) Weighting CPI
- measures the typical consumer’s cost of
living with only the typical things that are
purchased.
Consumer Price
Index (CPI)
- in which each item
influences the index in
proportion to its price per
it’s share.
Weighted Index
AS exams love to
mention this, so please
don’t forget it!

21. Different items in the
basket will
proportional be
counted as worth more
or less then other items.

22. Types of G &S
Proportion
spend by
households
Average price of
goods
Weighted average
price
Clothing 25 $40 0.25 x $40 = $10
Entertainment 15 $60 0.15 x $60 = 9
Food 40 $5 0.40 x $5 = $2
Travel 20 $20 0.20 x 20 = $4
2.1) Weighting CPI
Total = 100% Price of basket = $25
The proportion of total spending on each
category is used to weigh the average prices of
each good to find their weighted averages.
Let’s call this the base year…
Base Year5.) Attach
the weights

23. Types of G &S
Proportion
spend by
households
Average price of
goods
Weighted average
price
Clothing 25 $44 0.25 x $44 = $11
Entertainment 10 $90 0.10 x $90 = 9
Food 50 $8 0.50 x $8 = $4
Travel 15 $20 0.15 x 20 = $3
2.1) Weighting CPI
Total = 100% Price of basket = $27
Prices have changed, but so has the weighted
proportion of some items.
Current Year
100 x
Weighted average prices in current year
Weighted average prices in base year
$27
$25
CPI = 108=
5.) Attach
the weights

24. 2.) CPI – measuring Inflation
Inflation:
4.) Causes of Inflation
1.) Inflation Vocabulary
5.) Consequences of Inflation
3.) Problems of CPI

25. 3.) Problems of CPI
*** The general problem is that CPI
tends to overstate the actual increase
in the cost of living.
- Introduction of New Goods
- Substitution Bias
- Unmeasured Quality Change
- Discount sales

26. 3.) Problems of CPI
Substitution Bias - Over time, some prices rise
faster than others.
- Consumers substitute
toward goods that become
relatively cheaper.
- The CPI misses this
substitution because it uses
a fixed basket of goods.
偏见
Example:
You stop buying beef (in the CPI
basket) and buy lamb instead, (not in
the CPI basket) hard to know and
measure why people make these
choices and if they choice something
not in the basket.

27. 3.) Problems of CPI
Introduction of
New Goods
- The introduction of new
goods increases variety, allows
consumers to find products
that more closely meet their
needs.
-
- -The CPI misses this effect
because it uses a fixed basket
of goods.
Example:
You buy more Mini Ipads (not in the
basket) because they are new and
cheap, but since they are new they
can’t already be in the basket yet.

28. Everyone has a smart phone today, but
they did not exist 15 years ago, so when
should the government decide to put it
in the basket?

29. 3.) Problems of CPI
Unmeasured
Quality Change
- Improvements in the quality of
goods in the basket increase the
value of each dollar.
- The CPI tries to account for
quality changes but probably
misses some, as quality is hard to
measure.
Example:
Many electronic products today are
cheaper and better quality then in the
past, how to measure that?

30. Phones today are better and cheaper than
older phones, hard to measure this in
monetary terms.

31. 3.) Problems of CPI
- Firms may decrease prices
due to overstock or misreads of
the market.
-The CPI may not compensate
for these short term changes.
Discount sales
Example:
Stores often have sales, how can the
government keep track of all the prices
in the whole country when many places
have discounts and others don’t?

32. Prices online are much cheaper usually
right? So how to measure it exactly if
you’re the government?

33. To summarize so far…

34. - a sustained increase in the cost of living or
the general price level leading to a fall in
the purchasing power of money.
Inflation
- is measured by the annual percentage
change in consumer prices.
Rate of
Inflation
1.) Inflation Vocabulary
- when the rate of inflation becomes
negative.
Deflation
- the value of money becomes worthless.Hyperinflation
- ………………………….hless.Stagflation

35. - measures the typical consumer’s cost of
living with only the typical things that are
purchased.
- the main way to measure inflation.
Consumer Price
Index (CPI)
1.) Inflation Vocabulary

36. How the CPI Is Calculated:
- Government surveys consumers to
determine what’s in the typical consumer’s
“shopping basket.”
2.) CPI – measuring Inflation
1.) Fix the “basket”
- Government then collects data on the
prices of all the goods in the basket.
2.) Find the prices
3.) Compute the
basket’s cost
-Use the prices to
compute the total cost of
the basket.

37. How the CPI Is Calculated:
- The CPI in any year equals:
2.) CPI – measuring Inflation
4.) Choose a base year and compute the index
100 x
cost of basket in current year
cost of basket in base year
- The percentage change in the CPI from the preceding period:
6.) Compute the inflation rate
CPI this year – CPI last year
CPI last year
Inflation
rate
x 100%=
5.) ?

38. 2.1) Weighting CPI
- measures the typical consumer’s cost of
living with only the typical things that are
purchased.
Consumer Price
Index (CPI)
- in which each item
influences the index in
proportion to its price per
it’s share.
Weighted Index

39. {
Types of G &S
Proportion
spend by
households
Average price of
goods
Weighted average
price
Clothing 25 $44 0.25 x $44 = $11
Entertainment 10 $90 0.10 x $90 = 9
Food 50 $8 0.50 x $8 = $4
Travel 15 $20 0.15 x 20 = $3
2.1) Weighting CPI
Total = 100% Price of basket = $27
Prices have changed, but so has the weighted
proportion of some items.
Current Year
100 x
Weighted average prices in current year
Weighted average prices in base year
$27
$25
CPI = 108=
5.) Attach
the weights

40. 3.) Problems of CPI
*** The general problem is that CPI
tends to overstate the actual increase
in the cost of living.
- Introduction of New Goods
- Substitution Bias
- Unmeasured Quality Change
- Discount sales