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Deflation Stagflation Low inflation Some factors: Technology & Globalization
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Measuring Inflation Measuring Inflation using a Price Index
Historical Inflation
• Germany: “hyperinflation” after World War I– Currency became worthless
• USA: Late 1970s—Oil Crisis-- 13% inflation– Called “Stagflation”
• USA: low inflation since 1985 [2.0-3.0%]
• USA speed limit: target for inflation is underunder 2.5%
Deflation
Stagflation
Low inflation 1985 - 2012
Some factors: Technology & Globalization
What is a Price Index?• A price index is used by economists to measure inflation
– This allows you convert nominal numbers => to real numbers
• A price index must choose a base year which will = 100– You use “prices” of goods from this year for all goods & services
• For AP Econ we will analyze 2 price indices:– Consumer Price Index– GDP Deflator
Calculating % Change• You buy a stock at $8 per share • It is now at $10 per share
• If a price index rises from 100 to 125?
Formula: [(Ending Price – Beginning Price) / Beginning Price] * 100
(10-8)/8 * 100 = +25%
What % gain did you make?
(125-100)/100 * 100 = +25%
CPI Index• Consumer Price Index (CPI) measures consumer inflation
– You can use any year as a base year (which = 100)
• Uses a market “basket” of goods & services– Government prices basket monthly– Compares cost of the new basket to old basket
• CPI = Current Price Value of Basket
Price Value of Basket in Base Year X 100 = CPI Index
What is in the CPI’s Basket?
17%Transportation
15%Food and beverages
Medical care
6%
Recreation
6%
Apparel
4%
Other goodsand services
4%
42%Housing
6%Education and communication
CPI Index Calculation
Current Price Value of Basket
Price Value of Basket in Base Year X 100 = CPI Index
Price Value of Basket
2005 $102007 $12
($12/$10) X 100 = 120
Use 2005 as base year CPI Index = $10/$10 X 100 = 100
120 is the CPI Index for
2007
End Result:
Inflation rose 20%
(120 – 100)/100 X 100 = +20%
Worksheet
• Creating an Index
Problems with CPI
• Substitution Bias• New goods• Unmeasured quality changes• Housing Measurement
Basket must “evolve” with the market
Adjusting numbers for inflation
• Convert Babe Ruth’s wages in 1931 to 2005 dollars:
1931 Salary = $ 80,000 CPI = 15.2 1931
CPI = 195 2005
19515.2
X $80,000 = 1,026,316 (2005 dollars)
CPI Index (2005)
Base Year Index (1931)
X Old Dollar Value = 2005 dollars
Practice Test