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Chap 3

The document discusses the concepts of inflation, its causes, and how it is measured, particularly through the Consumer Price Index (CPI). It explains the difference between CPI and GDP deflator, as well as the implications of inflation on economic decisions and purchasing power. Additionally, it outlines the formula for calculating CPI and inflation rates, along with potential issues in measuring CPI.

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Tuấn Đỗ Anh
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6 views23 pages

Chap 3

The document discusses the concepts of inflation, its causes, and how it is measured, particularly through the Consumer Price Index (CPI). It explains the difference between CPI and GDP deflator, as well as the implications of inflation on economic decisions and purchasing power. Additionally, it outlines the formula for calculating CPI and inflation rates, along with potential issues in measuring CPI.

Uploaded by

Tuấn Đỗ Anh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 23

Macroeconomics

Dong Xuan Bach

Data Science program - NEU

2023

Dong Xuan Bach Macroeconomics 2023 1 / 23


Chapter 3: Consumer price index and
inflation rate

Understand the essence of inflation


How to calculate inflation rate
CPI in measuring the cost of livings
Comparing inflation rate measured by CPI and GDP deflator
Application of inflation rate in making economic decision

Dong Xuan Bach Macroeconomics 2023 2 / 23


Inflation

Dong Xuan Bach Macroeconomics 2023 3 / 23


Inflation

Inflation refers to a situation in which the economy’s overall


price level is consistently rising overtime.
The inflation rate is the percentage change in the price level
from the previous period.
In a healthy economy, annual inflation is typically in the range of
2%, which is what economists consider a signal of pricing
stability.
Inflation distorts the purchasing power for both consumers and
companies.

Dong Xuan Bach Macroeconomics 2023 4 / 23


Cause of inflation

Demand-pull inflation

When the total demand for goods and services (aggregate


demand) increases to exceed the supply of goods and services
(aggregate supply) that can be sustainably produced.
The excess demand puts upward pressure on prices across a
broad range of goods and services and ultimately leads to an
increase in inflation. That is, it pulls inflation higher.

Dong Xuan Bach Macroeconomics 2023 5 / 23


Dong Xuan Bach Macroeconomics 2023 6 / 23
Cause of inflation

Cost-push inflation

When the total supply of goods and services in the economy


which can be produced (aggregate supply) falls. A fall in
aggregate supply is often caused by an increase in the cost of
production.
If aggregate supply falls but aggregate demand remains
unchanged, there is upward pressure on prices and inflation –
that is, inflation is pushed higher.
Due to an increase in the price of domestic or imported inputs
or supply disruptions in specific industries.

Dong Xuan Bach Macroeconomics 2023 7 / 23


Dong Xuan Bach Macroeconomics 2023 8 / 23
Cause of inflation

Money supply
The quantity theory of money:

%∆M
| {z } + %∆V
| {z } = |%∆P
{z } + |%∆Y
{z }
Money supply Velocity Price Output

An increase in the supply of money is the root of inflation,


though this can play out through different mechanisms in the
economy:
Printing and giving away more money to citizens
Legally devaluing the legal tender currency
Loaning new money through the banking system by purchasing
government bonds from banks on the secondary market.
...

Dong Xuan Bach Macroeconomics 2023 9 / 23


Dong Xuan Bach Macroeconomics 2023 10 / 23
Measure inflation

The government measures inflation by comparing the current


prices of a set of goods and services to previous prices.
The three most commonly used methods to measure the
inflation rate are:
RPI - Retail Price Index: using an arithmetic mean. It
includes housing costs, mortgage interests, council taxes, and
rent
CPI - Consumer Price Index measures the percentage change
in the prices of a basket of goods and services of household
goods.
WPI- Wholesale Price Index calculates the rate of inflation at
the stages of wholesale and before they reach retail.
One can use also GDP deflator.

Dong Xuan Bach Macroeconomics 2023 11 / 23


Consumer Price Index

Dong Xuan Bach Macroeconomics 2023 12 / 23


Consumer Price Index

The CPI measures changes in prices of a fixed basket of


goods – a collection of items chosen to represent the purchasing
pattern of a typical consumer – in current year relative to base
year.
The CPI is the most widely used measure of inflation, closely
followed by policymakers, financial markets, businesses, and
consumers.

Dong Xuan Bach Macroeconomics 2023 13 / 23


Calculate CPI

Fix the Basket: Determine which goods and services are most
important to the typical consumer.
The General Statistical Office (GSO) identifies a market basket
of goods and services the typical consumer buys.
The year which we do a survey of basket of goods and services
bought by consumers is normally chosen as the base year

Dong Xuan Bach Macroeconomics 2023 14 / 23


Basket 2010

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Basket 2015

Dong Xuan Bach Macroeconomics 2023 16 / 23


Formula CPI

CPI (%)
P t 0
P Q
CPI = Pi i0 i0 × 100
t

i Pi Qi

where
Pit is the price of good i at the current year t
Pi0 is the price of good i at the based year 0
Qi0 is the quantity of good i in the basket.

Dong Xuan Bach Macroeconomics 2023 17 / 23


Compute Inflation rate

The inflation rate is the percentage change in the CPI from the
preceding period.

Inflation rate (%)


CPIt − CPIt−1
πt = × 100
CPIt−1
where
π t is the inflation rate at the current year t
CPIt is the price index at the current year t
CPIt−1 is the price index in the previous year t − 1

Dong Xuan Bach Macroeconomics 2023 18 / 23


Example

Dong Xuan Bach Macroeconomics 2023 19 / 23


Problems in measuring CPI

The CPI is an accurate measure of the selected goods that make up


the typical bundle, but it is not a perfect measure of the cost of living:

Substitution bias

Introduction of new goods

Unmeasured quality change

Dong Xuan Bach Macroeconomics 2023 20 / 23


CPI vs GDP deflator

CPI GDP deflator


Reflects the prices of all Reflects the prices of all
goods and services bought by goods and services produced
consumers domestically
Include imports Exclude imports
Only consumer goods and Also investment, gov.
services purchases, exports
Fixed basket Currently produced basket

Dong Xuan Bach Macroeconomics 2023 21 / 23


Correcting variables for the Inflation

Formula
CPIx
Variablex = Variabley ×
CPIy
where x and y represent the time.

Example: A person earned $80,000 in 1931 and another person


earned $800,000 in 2020. The CPI at year 2020 and 1931 are 177%
and 15.5% respectively. Then the wage in 1931 is equivalent to the
following amount of wage in 2020:

CPI2020 177
Real wage1931 = Wage1931 × 1931 = 80, 000 × = $931, 579
CPI 15.5

Dong Xuan Bach Macroeconomics 2023 22 / 23


Application of CPI

Wage bargain: The growth rate of real wage = the growth rate
of nominal wage - the inflation rate
Adjust banking interest rate: The nominal interest rate = The
real interest rate + the inflation rate.

Dong Xuan Bach Macroeconomics 2023 23 / 23

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