Comprehension check. Measuring inflation

MEASURING INFLATION

SUPPLEMENTARY READING

Almost everybody watches the rate of inflation. It is a major indicator of how the economy is doing. The rate of inflation is defined as the percentage rate of change in the general price level from one period to the next. The general price level is a measure of the purchasing power of the country’s currency, or the amount of goods and services the unit of the country’s currency can buy. There are two approaches to measuring the general price level: constructing price indexes directly from data on the prices of thousands of goods and services, and calculating deflators by dividing a component of nominal GDP by the same component of real GDP.

A price index is a ratio showing the price of a basket of goods and services in various years in relation to the price of the basket in a base year. The index is 100 in the base year and correspondingly higher in later years if the prices of the things in the basket have risen. The most conspicuous price index is the consumer price index (CPI). This index measures the cost of living for a typical urban family. The CPI is the most widely used measure of the purchasing power of the dollar. When people make an agreement that is set in dollars and want to protect themselves against inflation, they can write in a provision that payments rise in proportion to the increase in the CPI. This practice is called cost-of-living adjustment (COLA).

The government puts out another major price index in addition to the CPI. Formerly the wholesale price index, it is now called the producer price index (PPI). Instead of measuring the prices actually paid by consumers, it measures the prices charged by producers at various stages in the production process. All detailed prices go into the PPI and these prices and the price indexes computed from them are the best source of information about prices of crude materials and intermediate goods.

The construction of data on nominal and real GDP results in another type of price index. The purpose of measuring real GDP is to get rid of the price effects in nominal GDP. Thus, the ration of nominal GDP to real GDP is a measure of prices. It is called the GDP implicit price deflator.

Each component for GDP has a deflator. For example, the ratio of nominal consumption to real consumption is the consumption deflator. It is widely used as an alternative to the CPI as a measure of the cost of living.

1. How is the rate of inflation defined?

2. What two approaches to measuring the general price level do you know? Explain their essence.

3. What provision do people write to protect themselves against inflation?

Дата добавления: 2014-11-29