Inflation

1. Inflation
the concept, and measurement, of inflation

2. 2
Inflation
 Inflation may be defined as a persistent
and appreciable rise in the general
level of prices.
In reality, any rise in prices is classed
as inflation.

3. Inflation Key Points
 Rise in the general level of prices
 Persistent
 Appreciable
 Inflation reduces the purchasing power of Yd

4. 4
Measuring Inflation
 Inflation is measured by indexes which determine changes in the
price level.
 The indexes compare current prices with prices of an earlier
period called the base period.
 The base (first) period is given a value of 100 and the prices of
subsequent periods are compared against the base year.

5. 5
Measuring Inflation
 The most common measure of
inflation is the Consumer Price
Index (CPI).
 The prices of a large variety of
goods and services (known as a
‘basket’) are monitored on a
quarterly basis.

6. 6
Measuring Inflation
 For example, if the price of the basket had increased 15%
since the base year, the CPI would read 115, if the price
had fallen by 15% since the base year the CPI would be
85.

7. 7
Measuring Inflation
 It is important to remember that the CPI
measures price movements and not
actual price levels.

8. 8
Measuring Inflation
 For example, if the index for
beer is 108 and the
corresponding index for wine
during the same period is
104 it doesn’t mean that the
price of beer. Is more
expensive than wine.
u It means that the price of beer has
increased twice as much as that of wine
since the base year.

9. 9
Measuring Inflation
 Compilation of the CPI involves a quarterly survey
of a ‘basket’ of goods and services representing a
high proportion of household expenditure.

10. 10
Measuring Inflation
 The basket of goods and services upon which
the CPI is based is referred to as a regimen
and is divided into 11 groups.

11. The CPI Structure
The 11 groups are:
 Food
 Alcohol and tobacco
 Clothing and footwear
 Housing
 Household contents and services
 Health
 Transportation
 Communication
 Recreation
 Education
 Financial and insurance services

12. The CPI Structure (cont'd)
CPI Group weightings, across 8 capital cities.

13. 13
Measuring Inflation
 The CPI is a weighted index. Weights are allocated to categories of
spending to reflect the proportion of total expenditure on those
items.
e.g. if cleaning products make up 3% of expenditure, it accounts
for 3 out of 100 weights.

14. 14
Constructing the CPI Index
Period 1 Period 2
Commodity Weight Price WXP Price WXP
Food 40 0.65 26 0.80 32
Clothing 30 0.70 21 0.80 24
Housing 20 1.15 23 1.15 23
Recreation 10 1.00 10 1.10 11
Total 100 80 90
Price Index 100 112.50

15. 15
Measuring Inflation
 In order to find the annual rate of inflation, the following
formula applies:
Annual rate CPI (year 2) – CPI (year 1)
of inflation CPI (year 1)
x 100
Therefore
90 (Year 2) – 80 (Year 1)
x 100 = 112.5
80 (Year 1)

16. Measurement cont….
 Calculate the following: 1990 CPI = 105
2000 CPI = 126
 Inf% for the decade = [(126 - 105) ÷ 105] x 100
= (21 ÷ 105) x 100
= 20%

17. The consumer price index is calculated from prices of a ‘basket
of products’. This basket includes
A. all goods and services.
B. a sample of non-final goods and services.
C. a few retail goods and services.
D. a sample of all goods and services.
Answer = D