9.1 Tracking Inflation

Inflation is a key economic indicator that measures how fast prices are rising. By tracking changes in price levels over time, we can gauge the overall health of an economy and how it affects consumers' purchasing power.

Calculating inflation rates involves comparing price indices across different periods. These indices, like the Consumer Price Index (CPI), provide a standardized way to measure price changes for a typical basket of goods and services that households regularly purchase.

Measuring and Tracking Inflation

Calculation of inflation rate

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• Measures percentage change in average price level from one period to another
  • Formula: \text{[Inflation rate](https://www.fiveableKeyTerm:Inflation_Rate)} = \frac{\text{Current price level} - \text{Previous price level}}{\text{Previous price level}} \times 100\%
  • Example: If price level increases from 100 to 105, inflation rate is $\frac{105 - 100}{100} \times 100\% = 5\%$
• Positive rate indicates prices have increased on average (inflation)
• Negative rate indicates prices have decreased on average (deflation)
• Higher rates imply more rapidly increasing prices
  • 2% inflation means prices are increasing slowly
  • 10% inflation means prices are increasing quickly
  • Extreme cases can lead to hyperinflation, where prices rise at an exceptionally high and accelerating rate

Purpose of price indices

• Track changes in average price level over time
  • Consumer Price Index (CPI) measures average price of typical household goods and services (food, housing, transportation)
  • Producer Price Index (PPI) measures average price of goods and services sold by producers (raw materials, intermediate goods)
• Used to calculate inflation rates by comparing index values across periods
• Allow for consistent price comparisons over time
  • Basket of goods and services remains constant
  • Changes in index reflect price changes, not changes in basket composition
• Provide a standardized measure of price levels
  • Index values normalized to a base period (usually assigned a value of 100)
• Help measure changes in the cost of living for consumers

Comparison of inflation rates

• Index numbers express price level relative to base period
  • Formula: $\text{Index number} = \frac{\text{Current price level}}{\text{Base period price level}} \times 100$
  • Example: If current price level is 110 and base period price level was 100, index number is $\frac{110}{100} \times 100 = 110$
• Comparing index numbers reveals changes in price level
  • Index number above 100 indicates prices have increased since base period
  • Index number below 100 indicates prices have decreased since base period
• Difference between index numbers used to calculate inflation rate
  • Formula: $\text{Inflation rate} = \frac{\text{Current period index} - \text{Previous period index}}{\text{Previous period index}} \times 100\%$
  • Example: If current index is 110 and previous index was 105, inflation rate is $\frac{110 - 105}{105} \times 100\% \approx 4.76\%$
• Inflation rates calculated using index numbers are directly comparable across different time periods
  • Accounts for differences in base price levels
  • Allows for "apples-to-apples" comparisons of inflation over time

Types of Inflation Measures

• Core inflation: excludes volatile food and energy prices to provide a more stable measure of long-term inflation trends
• Stagflation: a combination of high inflation and slow economic growth, often accompanied by high unemployment