Economics

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# Economics - PowerPoint PPT Presentation

Economics. Chapter 2 General Price Level. General Price Level. General price level Weighted average of prices of all goods and services. Shown by different price indexes Price index A figure showing the price level of the same basket of goods and services. Base period vs. specific period

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Presentation Transcript

### Economics

Chapter 2

General Price Level

General Price Level
• General price level
• Weighted average of prices of all goods and services.
• Shown by different price indexes
• Price index
• A figure showing the price level of the same basket of goods and services.
• Base period vs. specific period
• At base year, always set at 100
Consumer Price Index (CPI)
• Price level of goods and services generally consumed by household.
Consumer Price Index (CPI)
• HK Statistics: Base year = 2004-2005
The implicit price deflator of GDP
• Simply: GDP deflator
• Measure the price change of all types of goods included in GDP.
• Formula:
Coverage
• CPI
• Products consumed by household
• Fixed basket of goods and services. (Same for diff. yrs)
• Imports , Exports 
• Capital goods 
• GDP deflator
• Counting all GDP components: C + I + G + X - M.
• Exports , imports 
• Capital goods (I) 
CPI vs. GDP deflator
• Aim at
• CPI
• Change in the cost of living
• Amount spent on basic living expenses
• GDP deflator
• Amount of goods that can be bought with a unit of money
Inflation
• Definition:The persistent increase in the general price level.
• Shown by CPI  continuously.
• Hong Kong Statistics:

Inflation rate =

Deflation
• Definition:
• The persistent decrease in the general price level.
• Inflation rate is negative
Inflation
• Given the CPIs of Economy A
• Find the inflation rate in 2009.
• Find the inflation rate in 2010.
CPI vs. GDP deflator
• Aim at
• CPI
• Change in the cost of living
• Amount spent on basic living expenses
• GDP deflator
• Amount of goods that can be bought with money
• In 2009
• A hamburger = \$10
• i.e. You can buy a hamburger if you got a \$10 note
• In 2010
• A hamburger = \$12
• i.e. You can’t buy a hamburger with a \$10 note
• The purchasing power of the \$10 note is lowered
CPI - Overestimation

Substitution bias:

If Price of Good A  Choose Good B (substitute)

Although CPI (Good A), people are not fully affected

Same living standard

CPI overestimate the increase in price level

CPI - Overestimation
• Quality improvement:
• Products with high technology (e.g. new mobile phone)
• Buy same amount (same expense)  better enjoy

or

• Buy the same old model (less expense)  same enjoy
• CPI can’t reflect the change in enjoyment
Which price index is better? (Textbook p.60-61)

a. Calculate the inflation rates of 2004 and 2005.

Inflation rate =

b. Describe the changes in inflation rates and cost of living with reference to the GDP deflator and Composite CPI.

Base on GDP deflator:

a ______ inflation rate in 2004 suggests a ________ in the cost of living.

a ______ inflation rate in 2005 showing that the cost of living__________________.

Base of Composite CPI:

a ______ inflation rate in 2004 suggests a ________ in the cost of living.

a ______ inflation rate in 2005 suggests a ________ in the cost of living.

Which price index is better? (Textbook p.60-61)

negative

decrease

zero

remains unchanged

negative

decrease

positve

increase

c. Which index is a better indicator of inflation? Which index is a better indicator of the cost of living?

Inflation refers to ___________________________________________

As the ______________ measure price changes of a large scope of goods, it is better indicator of inflation

Cost of living refers to ___________________________________________

It is affected by price change in _________ goods only.

Therefore, ________ , which includes only _________ goods, is a better indicator of the cost of living.

Which price index is better? (Textbook p.60-61)

A persistent increase in the general price level

GDP deflator

amount spent on basic living expenses

consumer

consumer

CPI

Which index is better?
• GDP deflator
• Prices change of a large scope of goods
• Better for measuring inflation
• CPI
• Price change of consumer goods
• Better for indicating living standard