Measuring Economic Wellness Another Method Measuring Price Stability

Measuring Economic Wellness: Another Method: Measuring Price Stability

Price Stability • one of the main economic goals of national governments • if prices rise faster than incomes, people cannot afford to purchase goods • results: drop in sales=drop in production=slowdowns, shut downs=job losses=reduced tax revenues, etc.

Inflation • the persistent rise in the general level of prices • prices increase annually for variety of reasons • Examples: - increasing consumer demand (shifts demand curves upward to the left=prices rise) - increases in prices of productive resources (ie. land, labour, capital) as they become scarcer

The C. P. I. • C. P. I. = Consumer Price Index • used by Canadian gov’t to track inflation • measures the percentage change in prices of consumer goods between one year and the next (aka the inflation rate)

Calculating the C. P. I. • Stats. Can collects data on a representative “shopping basket” of 600 consumer goods/services • typical “household” assumed to be urban with 4 members per household

• each of the 600 items placed in one of 8 categories • each category is “weighted” based on how much the typical household tends to spend on items in that category

Recreation, education and reading 11. 2% Categories for Calculating Canada’s CPI, 2012 Food 15. 99% Alcohol and tobacco products 2. 91% Health and personal care 4. 95% Transportation 20. 6% Shelter 27. 49% Household operations, furnishings and equipment 11. 55% Clothing and footwear 5. 31%

Using the CPI to Calculate the Inflation Rate •

A quick example: •

So What, you ask? • Who uses the CPI and why? • Governments, labour unions, wage earners, pensioners • CPI/inflation rate used to figure out how wages and pensions should be adjusted to account for inflation (ex. during contract negotiations)

COLA (? ? ) • “indexing”– increase wages/pensions at same rate as inflation to cover increased costs caused by inflation • aka “C. O. L. A. ” = Cost of Living Allowance • Can be fully indexed or partially indexed

Limitations of the CPI a) many households do not match the norms of Stats. Can’s “typical” household • Ex. family size, smoking vs. non-smoking, Arctic vs. Southern Canada, etc. b) spending habits/products can change, often rapidly, over time – basket items and weights need to be updated periodically – can they keep pace with reality? c) multi-culturalism: expenses of maintaining one’s unique cultural practices may be greater than CPI compensates for – pension/wage indexing may “understate” one’s actual cost of living

Other Inflation Tidbits: • “core rate of inflation” – basket of goods has most volatile elements removed • fruit, vegetables, fuel oil, gasoline, natural gas, mortgage interest, intercity transp. , tobacco • Federal gov’t & Bank of Canada watch core rate most closely

• “target rate of inflation”: Bank of Canada tries to keep core rate between 1% - 3% (ideally 2%) • Bo. C uses interest rates to keep inflation within target area (raises rates if inflation too high, lowers rates if inflation too low)

• “deflation”: prices falling rather than rising annually • in short run, OK – industry productivity & efficiency rising (ex. 19 th C. England) • could result in spiralling (uncontrollable) decreases as people keep putting off purchases • sales drop, layoffs, closures, reduced revenues & taxes, etc.

• “stagflation”: inflation rising but economic growth, purchasing power stagnating • 1970’s: rising oil prices drive up prices generally – drop in consumer spending, layoffs, etc. • profits, wealth transferred out of Cdn. economy into oil producing countries

• “hyperinflation”: vicious cycle of rapidly increasing prices • extreme ex. of “too many dollars chasing too few goods” : gov’ts print money to stimulate demand BUT • demand doesn’t grow fast enough – value of currency drops

• Examples • 1920’s Ger. : inflation hits 3. 25 million % per month • 1940’s Hungary: 4. 19 quintillion (10 18) % per month • 1993: Yugoslavia issues a 500 billion dinar bill • 2008: Zimbabwe at 6. 5 sextillion (10 21 )% per month - one US dollar buys 1 billion Zimbabwean dollars (at par in 1983) • 2009 - 2014: Zimbabwe has no national currency – other world currencies are used in everyday business

Zimbabwean inflation rates since independence (official up to Jul. 2008, estimates thereafter) Date Rate Date Rate 1980 7% 1986 15% 1992 40% 1998 48% 2004 132. 75% 2008 Sep. 3, 840, 000, 000% 1981 14% 1987 10% 1993 20% 1999 56. 9% 2005 585. 84% 2008 Mid-Nov. 89, 700, 000, 000% 1982 15% 1988 7. 3% 1994 25% 2000 55. 22% 2006 1, 281. 11% 1983 19% 1989 14% 1995 28% 2001 112. 1% 2007 66, 212. 3% 1984 10% 1990 17% 1996 16% 2002 198. 93% 2008 Jul. 231, 150, 888. 87% 1985 10% 1991 48% 1997 20% 2003 598. 75% 2008 Aug. 471, 000, 000%

Thinking Like an Economist: Practicing the CPI • Read p. 208 – 209 “Constructing a Price Index”, then answer Qu. 1 on p. 209 • Read “Indexing to the CPI” on p. 211, then answer Qu. ’s #1 & 2 on p. 211