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# Lecture03 - Inflation measurement Convert nominal value to...

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1 Inflation measurement • Convert nominal value to real (deflation) • Provide a measure of inflation • Price index construction – Appropriate average of prices for deflation and measuring inflation Some notation • Let X t be the level of variable X at time t • Denote x t = ( X t X t-1 )/ X t-1 be the growth rate of X t • E.g., if P t is the price level , then p t = ( P t P t-1 )/ P t-1 is the inflation rate Defining the general price level P t is the general price level – Do not confuse with relative prices (one good relative to another) – Index of average prices – Measure of the overall trend in prices (inflation) – Scale is arbitrary: rate of change is the fundamental

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2 Constructing price indexes • Issue: Want the average rate of change – Many different goods and services – Relative price change Constructing price indexes • Let p it be the growth rate of good i • Problem: How to average these goods- level growth rates to construct the inflation rate p t – Note: no subscript for general price level   1 Let where is a weight N ti i t i i pp Constructing price indexes 1 N i t i p p So what should the weights be?  1 share of total sales ii i N i PQ
3 Example Good Share Growth in price Share x Growth in price Apples 0.90 5% 4.5% Oranges 0.10 10% 1.0% Total 1.00 5.5%

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Lecture03 - Inflation measurement Convert nominal value to...

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