AP Economics
Mr. Bernstein
Module 15:
The Measurement and Calculation of
Inflation
January 2016
AP Economics
Mr. Bernstein
Measurement and Calculation of Inflation
• Objectives - Understand each of the following:
• How the inflation rate is measured
• What a price index is and how it is calculated
• The importance of the Consumer Price Index and other
price indexes
2
AP Economics
Mr. Bernstein
Price Indexes and the Aggregate Price Level
• Market Basket is made
up of typical goods and
services purchased
• Measuring broad level
of inflation, not individual
goods and services
3
AP Economics
Mr. Bernstein
Market Baskets and Price Indexes
• Price index in a given year =
(cost of the market basket in year t)/(cost of the
market basket in the base year)
• Inflation rate = percentage change between any
two values of the index, ie (CPI2013 - CPI2012) / CPI2012
• Note: Index value in base year = 100
4
AP Economics
Mr. Bernstein
Example: The Deli Index
Item in the
Deli Basket
Quantity
Consumed in
a Typical Year
2012 Price
per Pound
2013 Price
per Pound
Corned Beef
300
$4
$6
Salami
200
$5
$7
Turkey
100
$2
$1.50
Cheese
500
$3
$2.50
• 2012 cost = (300*4)+(200*5)+(100*2)+(500*3)=3900
• 2013 cost = (300*6)+(200*7)+(100*1.5)+(500*2.5)=4600
• DPI (Deli Price Index) increased (4600/3900)-1 = ~18% even
though 2 items actually declined in price
5
AP Economics
Mr. Bernstein
Consumer Price Index (CPI)
• Computed monthly using a market basket of
~80,000 goods and services consumed by a typical
urban family
• Most widely used measure of inflation
• Producer Price Index (PPI) measures inflation in
inputs used by businesses rather than final
products
• GDP Deflator (Ratio of Nominal GDP to Real GDP)
often used in same way, although technically its
not an index.
• Note: Base year for GDP is currently 2000
6
AP Economics
Mr. Bernstein
Coincidence of Inflation Measures
7