Measuring Inflation using a Price Index Historical Inflation

Measuring Inflation using a Price Index

Historical Inflation • Germany: “hyperinflation” after World War I – Currency became worthless • USA: Late 1970 s—Oil Crisis-- 13% inflation – Called “Stagflation” • USA: low inflation since 1985 [2. 0 -3. 0%] • USA speed limit: target for inflation is under 2. 5%

Some factors: Technology & Globalization Stagflation Low inflation 1985 - 2012 Deflation

What is a Price Index? • A price index is used by economists to: – measure the inflation rate – convert nominal numbers => to real numbers • A price index will choose a base year (which always = 100) – Use the prices from base year for all goods/services

CPI Index • Consumer Price Index (CPI) measures consumer inflation • CPI uses a consumer market “basket” of goods & services – Government prices market basket each month – Compares cost of the new basket to old basket 2011: Market Basket cost $1, 000 2012: Market Basket cost $1, 100 So inflation = +10. 0%

What is in the CPI’s Market Basket? 17% Transportation 15% Food and beverages Education and communication 6% 42% Housing 6% 6% 4% 4% Medical care Recreation Apparel Other goods and services

CPI Index Calculation Current $ Value Basket X 100 = CPI Index $ Value Basket in Base Year Price ($) Value of Basket 2005 2007 Use 2005 as base year CPI Index = $10/$10 X 100 = 100 $12 CPI Index for 2007 ($12/$10) X 100 = 120 End Result From 2005 => 2007 Inflation rose +20% (120 – 100)/100 X 100 = +20%

% Change with Price Index • If a price index rises from 100 to 120? What % gain did you make? Formula: [(Ending Index – Beginning Index) / Beginning Index] * 100 (120 -100)/100 * 100 = +20%

Worksheet • Creating an Index