The Measurement and Calculation of Inflation - Section 3, Module 15

aggregate price level - a single number representing the overall level of prices

to measure average price changes for consumer goods and services, changes in the cost of a typical consumers’ consumption bundle is tracked

market basket - hypothetical consumption bundle used to track the change in overall price level

the changes are calculated relative to the base year - year chosen as “comparison year”

price index - a measure of the overall price level compared to the prices in the base year

• price index formula:

• used in consumer and producer price index

• also used for inflation:

consumer price index - most widely used measure of the overall price level → intended to show how the cost of all purchases by a typical urban family has changed over time

many payments are indexed (tied) to the CPI - the amount paid for goods and services rises/falls based on the CPI

amount of SSN check is determined by a formula that reflects person’s previous payments into the system

cpi systematically overstates the actual price of inflation

• each item remains in the market basket for 4 years but consumers frequently mix the goods and services they buy - ESP when prices of goods rise

  • substitution bias - when items with that have risen in price more receive too much weight (bc households substitute away from them) while items that have lowered in price receive too little weight (bc households substitute towards them)

• better product = obviously higher price → not really inflation, but sometimes not really well adjusted to CPI

• innovation - widens the range of consumer choice and makes a given amount of money worth more

producer price index - measures the cost of a typical basket of goods/services purchased by producers

• PPI often responds to inflationary/deflationary pressures more quickly than CPI bc commodity producers are relatively quick to raise prices when they perceive a change in overall demand for their goods

GDP Deflator - 100 times the ration of nominal GDP to real GDP