Module 2 - Inflation

# Module 2 - Inflation - MACROECONOMICS(ECON 102 Inflation...

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MACROECONOMICS (ECON 102) Inflation Module 2 10/23/15 1 Prepared by: Ms. Rubeena Mahaboob

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What is Inflation? Price level is the average level of prices measured by a price index. Price index is a normalized average of prices for a given class of goods or services in a given region, during a given interval of time. It is the index that tracks inflation by measuring price changes. Inflation is a rise in the general price level , over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money. The inflation rate is the percentage change in the price level from one year to the next. The annual inflation rate is the percentage change in prices over a twelve month period. Inflation is measured by the Consumer Price Index (CPI ). 10/23/15 2
What is Inflation? Consumer Price Index (CPI ) : This is the price of a basket of the normal goods and services people buy. It may also be measured by the GDP Deflator 10/23/15 3

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GDP Deflator GDP deflator measures the ratio of nominal GDP to the real GDP times 100. GDP deflator is a factor which is used to compare today's market prices to the market prices from a previous year. Nominal GDP reflects both the quantities of goods and services the economy is producing and the prices of those goods and services. Real GDP reflects only the quantities produced by holding prices constant at base-year level. 10/23/15 4
GDP Deflator Calculating the GDP Deflator Using the following data calculate the GDP Deflator. GDP deflator for the year 2008, GDP deflator = \$ 200 / \$ 200 x 100 = \$ 100 GDP deflator for the year 2009, GDP deflator = \$ 600 / \$ 350 x 100 = \$ 171 GDP deflator for the year 2010, GDP deflator = \$ 1,200 / \$ 500 = \$ 240 10/23/15 5 Year Nominal GDP Real GDP 2008 \$ 200 \$ 200 2009 \$ 600 \$ 350 2010 \$ 1,200 \$ 500

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How is the CPI measured? The consumer price index (CPI) is a price index based on expenditure of a typical metropolitan family. It included prices on more than 100 goods and services, including: HOUSING TRANSPORT FOOD MEDICAL EXPENSES ENTERTAINMENT The price of each item is weighted by the proportion of the representative family’s expenditure on this item. The more of the family’s income spent on an item the bigger the weight and the larger the effect that item has on the CPI. For example a 10% rise in the cost of petrol has a bigger impact than a 10% increase in the price of a box of toothpicks. 10/23/15 6
How is the CPI measured? Consider a simple economy in which consumers buy only two goods: Books and Pens. There are five steps to calculate CPI. They are as follows, 1. Fix the basket: Determine which prices are most important to the typical consumer. If the consumer buys more books than pens, then the price of books is more important than the price of pens. Therefore ,should be given greater weight to the price of books in measuring the CPI (cost of living).

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