Inflation and Price Measurement Fundamentals Free Online FlashCards

What does a price index measure?

The price level is the average level of prices for goods and services in an economy; a price index summarizes it using a selected basket.

How do you calculate a price index?

Price Index = (cost of basket in current year ÷ cost of basket in base year) × 100. A base-year basket cost of $1,000 and current cost of $1,080 gives an index of 108.

How is the inflation rate calculated?

Inflation rate = [(price index in period t − price index in the previous period) ÷ previous-period index] × 100. From 120 to 126, inflation is 5%.

What does the CPI measure?

The CPI measures the average change over time in prices paid by urban consumers for a market basket of consumer goods and services.

What are the three basic steps in calculating the CPI?

Choose a representative market basket, collect prices for its items over time, and compare the basket’s cost with its cost in the base period.

Why is the CPI called a weighted index?

A price change has a larger effect on the CPI when the item represents a larger share of household spending. Housing therefore usually matters more than an infrequently purchased item.

How do the GDP price index and CPI differ?

The GDP price index covers goods and services produced domestically, including exports but excluding imports. The CPI covers goods and services purchased by urban consumers.

What distinguishes disinflation from deflation?

Disinflation is a decrease in the inflation rate while inflation remains positive. Deflation is a sustained decrease in the general price level, producing a negative inflation rate.

What is the difference between nominal and real values?

A nominal value uses prices prevailing at the time of measurement. A real value is adjusted for price-level changes and therefore reflects purchasing power more closely.

How can you approximate real growth?

Real growth ≈ nominal growth − inflation. If nominal income rises 8% and inflation is 5%, real income rises approximately 3%.

How do you convert a nominal value into a real value?

Real Value = Nominal Value ÷ (Price Index ÷ 100). Thus, nominal GDP of $25 trillion with an index of 125 equals $20 trillion in real GDP.

How does inflation affect purchasing power?

Purchasing power is the quantity of goods and services a unit of money can buy. When the price level rises, purchasing power falls; when it falls, purchasing power rises.