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Inflation

Frederick University 2014

Definition

A process of irreversible increase in the overall price level, involving a change in relative prices

Typology

- According to the form – open and hidden
- According to the rate of price growth – moderate, galloping, hyperinflation
- According to expectations anticipated and unanticipated
- According to source – driven by MS or MD, byAS

Measurement

- GDP deflator
- Consumer Price Index (CPI)

GDP deflator

- Nominal GDP – GDP at current prices
- Real GDP – GDP at constant prices (base year prices – chosen year)
- Index – the change in the value of an indicator compared to its previous level, taken as a base (= 100)
- GDP deflator =
(Nominal GDP: Real GDP) х 100

GDP deflator is a current year weighted index

Consumer Price Index

- Consumer basket
- Relative shares of goods in the consumer basket - g
- CPI = [(P1A/ P0A)x g0A + (P1B/P0B)x g0B]x 100
- Rate of inflation = [(CPI – 100)/100]x 100%
- CPI is a base year weighted index

There are two goods in the economy – movies and wine

Р of movies in 2010 г. = €5.

Р of winein 2010 г. = €4.

Qof movies in 2010 г. = 400

Qof wine in 2010 г. = 2000

The cost of consumer basket = 400 x € 5 + 2000 x €4 = =€ 10000

€ 2000 out of these €10000 were spent on movies. This makes 20% or 0.2 of all money spent on movies.

Thus, the relative weight (g) of moviesin 2010 = 0.20

g of wine = 0.80

Р of movies in 2011 = €8

Р of wine in 2011 = €3

CPI = [(8/5) х 0.20 + (3/ 4) x 0.80) x 100 = 93

Rate of inflation =

= (93 -100)/100 x 100% = = -7%

If the CPI were above 100, the rate of inflation would have been positive.

CPI an example
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