calculating inflation: price change, cpi, and the gdp deflator
TRANSCRIPT
CALCULATING INFLATION:
PRICE CHANGE, CPI, AND THE GDP DEFLATOR
INFLATION FOR A SINGLE GOOD
Inflation is the percent change in
prices.
Therefore, in its simplest form,
inflation can be calculated as:• (Price in Year 2 - Price in Base
Year) x 100 Price in Base Year
MEASURING AGGREGATE PRICE
CHANGES
How do you measure overall
inflation for an entire economy’s
worth of goods?
Two most common methods: • the Consumer Price Index (CPI) and• The GDP Deflator
THE CONSUMER PRICE INDEX (CPI)
Combines the prices of a bundle of
goods and services.
Based on a market basket of more
than 200 categories of goods and
services weighted according to how
much the average consumer spends on
them.
CONSUMER PRICE INDEX
CPI= Cost of market basket in current-year prices x 100
Cost of market basket in base-year prices
DOWNSIDE TO USING CPI
Substitution bias –• As the price of a good rises, people will buy
more of the good’s substitute. With more of the substitute being purchased, the CPI will account for the substitute and reflect no overall change in the price level of the economy while the original good did in fact change in price.
DOWNSIDE TO USING CPI
Introduction of new goods –
• When new goods are introduced to an economy, they typically have a short-term high price. Over time, the price decreases to an equilibrium price. The CPI often accounts for the good at its high price, consequently creating a higher price level than what is accurate.
DOWNSIDE TO USING CPI
Improvement in quality –
• The CPI does not account for changes in quality of goods and services. When incomes are high, people will buy more luxury goods while non-luxury versions of the same goods are available. The CPI will increase as average prices of the goods increase because more people buy the luxury version. This leads to an increase in the CPI when prices may not have necessarily changed at all.
GDP DEFLATOR
GDP deflator measures price
changes in current year compared
to those in a base year FOR ALL
GOODS AND SERVICES produced
within the economy.
GDP DEFLATOR
To Calculate:
•Nominal GDP x 100
Real GDP
CPI VS. GDP DEFLATOR
CPI GDP Deflator
Is calculated based on a FIXED BASKET of goods
and services
The data is not based on a basket of goods but on the economy as a whole
Much simpler for Economists to calculate and the data is available much sooner than GDP
Deflator data.
GDP Deflator is not affected by changes in
tastes or the introduction of new products in the
market
USING THE CPI AND GDP DEFLATOR TO CALCULATE
INFLATION
Inflation rate =
Price Index year 2 – Price Index year 1
Price Index year 1
USING PRICE IN DICES T O CALCULATE REAL GDP
Price Index =
Therefore…
Real GDP =
ASSIGNMENT
Complete page 67-69 of the packet you
received on Thursday
Complete problems 3, 7, and 10 on pages 151-
153 (due Wednesday)
Read Modules 12 and 13 for Wednesday.
Quiz Wednesday on calculating GDP and
Inflation.