Measuring Inflation

Methods of Measuring Inflation

• The Consumer Price Index (CPI) is the average price of goods and services that consumers typically buy expressed as an index.

• These goods and services are called the "market basket".
• The market basket is different for every population.
• There are two ways to look at inflation over time
  • The inflation rate
  • Price index
• Inflation rate is given as a percentage number.
• The price index is given as a number 100 + x (unless there is deflation, where it is 100 -x)

Calculating CPI

• The market basket adds up to all of the items in each year.
• The total market basket is the sum of all the prices for each year of every good in the market basket.
• CPI uses the market basket to measure inflation.

• The base year is given an index of 100.
• Each following year is also given an index.

• CPI is always measured according to a designated base year.
• CPI = price of market basket (current year)/price of market basket (base year) * 100
• An index number like CPI is similar to a percentage number.

• For example, a CPI of 150 means there has been a 50% inflation in prices since the base year.
• Thus the current market basket is 150% the price of the base year's market basket.

Example

• 2000: The total market basket is 20 euros (base year), index = 100
• 2006: The total market basket is 25 euros (current year), index = 125
• This means there has been a 25% increase in price.

CPI Weighted Index (HL)

• Certain product categories can be weighted, to have a greater affect on the market basket.
• They are multiplied by a number to increase or reduce their value, affecting the total market basket.
• The weighting is the percentage of expenditure a product takes up.
• This means that products that take up a small percentage of expenditure do not influence the total market basket much.

Calculating Inflation Rate

• Inflation rate only looks at the previous year, instead of at a base year like CPI.

• It is calculated as:
  • Inflation rate = market basket of current year/market basket of previous year * 100%