Inflation

Agec 217, Summer 2007

Inflation

• Top Box Office Movies of All Time:http://movies.yahoo.com/mv/boxoffice/alltime/

• Gone with the Wind (1939): ranked 77th – Tickets in 1939 $0.23– Tickets in 2007 $6.58

Inflation

• Inflation: An increase in the overall level of prices in the economy

• Inflation Rate: The percentage change in prices from the preceding period

Historical Inflation

Inflation• Your rent under 20% inflation during four

years at Purdue– Year 1: $ 500 / month– Year 2: $ 600 / month– Year 3: $ 720 / month– Year 4: $ 864 / month– Year 5: $1,037 / month

• Rent doubles in 4 years (year 5 – year 1)

Inflation

• What if prices increase dramatically and wages do not keep up

• Hyperinflation: out of control inflation, often above the 20% - 30% range

Inflation

• Mexican Peso

– 1993: Nuevo Peso = 1,000 Pesos

– 1996: Dropped the “Nuevo Term”

• Essentially devalued the Peso multiple of 1,000

Inflation

• Hungary after WWII– July, 1946 (Pengo)

• Inflation Rate41,900,000,000,000,000%

• Prices doubled every 15 hours

• Forint: August, 1946– 400 octillion Pengo

Inflation

• Top Box Office Movies of All Time– (adjusted for inflation):http://www.boxofficemojo.com/alltime/adjusted.htm

• Gone with the Wind (1939): now ranked 1st – Tickets in 1939 $0.23– Tickets in 2007 $6.58

Inflation

• Issues with GDP Deflator for Inflation

– Measure what is produced domestically, not what consumers actually buy• Imports consumed but not produced here• Government and Investment produced here but not

consumed

– Current products disappear and new products appear

Consumer Price Index

• Measures a “basket” of goods as purchased by the typical consumer

– Only addresses the first problem of GDP deflator– Still issue with changing baskets over time

CPI Data Collection

• Bureau of Labor Statistics - http://www.bls.gov/cpi

-Current CPI: 2001 and 2002-10,000 families interviewed each quarter- 7,500 families tracked habits for two weeks-Only looks at average urban consumers (87% of

population)

CPI Components• FOOD AND BEVERAGES• HOUSING• APPAREL• TRANSPORTATION• MEDICAL CARE• RECREATION• EDUCATION AND COMMUNICATION• OTHER GOODS AND SERVICES• GOVERNMENT FEES FOR SERVICES• TAXES PAID WITH PURCHASE OF OTHER GOODS

CPI Measured

• After surveying consumers, the Bureau of Labor Statistics determines the following diets and prices:

– 2005: 500 pizza slices and 300 sodas• Prices: pizza = $1.00 and soda = $0.50

– 2006: 550 pizza slices and 330 sodas• Prices: pizza = $1.10 and soda = $1.00

CPI Measured

• The Bureau of Labor Statistics determines a typical consumer basket based on survey data:

– Let’s say the consumer basket is

• 525 pizza slices and 315 sodas

CPI Measured

• Price of the consumer’s basket

– 2005• 525 * $1.00 + 315 * $0.50 = $682.50

– 2006• 525 * $1.10 + 315 * $1.00 = $895.50

– Percent change = 31.2% inflation

CPI Measured

• Consumer Price Index (base year = 2005)– Calculation• (Basket Price / Basket Price for base year) * 100

– 2005• ($682.5 / 682.5) * 100 = 100

– 2006• ($895.5/ 682.5) * 100 = 131

Using CPI

• Calculate Inflation from CPI (all CPI’s must be based on the same base year)

– Calculation• ((CPI current year/CPI previous year) – 1) * 100

– 2006• ((131 / 100) – 1) * 100 = 31% inflation

CPI Issues

• What if the basket changes?

• Computers and comparable products over time

• VCR’s and price inflation

Historical CPI and GDP deflator

Summary

• CPI is different than the GDP deflator in that is measures what consumers actually use, as opposed to what is produced domestically. While there are some drawbacks, it is the most widely used measure of inflation.