1Measuring the Price Level and InflationMeasuring the Price Level and InflationPrinciples of Macroeconomics Dr. Gabriel X. MartinezAve Maria UniversityChapter 19: Measuring the Price Chapter 19: Measuring the Price Level and InflationLevel and Inflation22Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved. IntroductionIntroductionWhat is the lowest price you remember for a What is the lowest price you remember for a can of Coke?can of Coke?What is the current price?What is the current price?Are we all poorer because of this?Are we all poorer because of this?How can we measure these changes?How can we measure these changes?Chapter 19: Measuring the Price Chapter 19: Measuring the Price Level and InflationLevel and Inflation33Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved. IntroductionIntroductionA A market basket:market basket:––Describes all the things that a consumer Describes all the things that a consumer purchases in a given time period called a purchases in a given time period called a base base yearyear..––The prices of items in the market basket are The prices of items in the market basket are weighted by the importance of the item in the weighted by the importance of the item in the consumerconsumer’’s purchase habits.s purchase habits.––Example:Example:The one automobile purchased during the year The one automobile purchased during the year enters at the price of the car, say $25,000.enters at the price of the car, say $25,000.The five cans of beans costing 99The five cans of beans costing 99¢¢each is entered each is entered as 5 X 99 = $4.95.as 5 X 99 = $4.95.Chapter 19: Measuring the Price Chapter 19: Measuring the Price Level and InflationLevel and Inflation44Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved. A A market basket:market basket:––Describes all the things that a consumer Describes all the things that a consumer purchases in a given time period called a purchases in a given time period called a base base yearyear..––The prices of items in the market basket are The prices of items in the market basket are weighted by the importance of the item in the weighted by the importance of the item in the consumerconsumer’’s purchase habits.s purchase habits.––Example:Example:The one automobile purchased during the year The one automobile purchased during the year enters at the price of the car, say $25,000.enters at the price of the car, say $25,000.The five cans of beans costing 99The five cans of beans costing 99¢¢each is entered each is entered as 5 X 99 = $4.95.as 5 X 99 = $4.95.IntroductionIntroductionChapter 19: Measuring the Price Chapter 19: Measuring the Price Level and InflationLevel and Inflation55Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved. IntroductionIntroductionA A base yearbase year––is arbitrarily chosen as a is arbitrarily chosen as a reference pointreference pointfor the for the price comparisons.price comparisons.A A price indexprice index––compares the prices of the market basket in the compares the prices of the market basket in the base year with the prices of the base year with the prices of the same basketsame basketin in a target (current) year.a target (current) year.$base year$current yearMeasuring the Price LevelMeasuring the Price Level2Chapter 19: Measuring the Price Chapter 19: Measuring the Price Level and InflationLevel and Inflation77Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved. The Consumer Price Index: The Consumer Price Index: Measuring the Price LevelMeasuring the Price LevelConsumer Price Index (CPI)Consumer Price Index (CPI)––For any period, For any period, ……––……measures the cost in that period of a standard measures the cost in that period of a standard basket of goods and services (for an urban basket of goods and services (for an urban consumer) consumer) ……––……relative to the cost of the same basket of relative to the cost of the same basket of goods and servicesgoods and services……––……in a fixed year, called the in a fixed year, called the base year.base year.Chapter 19: Measuring the Price Chapter 19: Measuring the Price Level and InflationLevel and Inflation88Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved. The Consumer Price Index: The Consumer Price Index: Measuring the Price LevelMeasuring the Price LevelConsumer Price Index (CPI)Consumer Price Index (CPI)100year basein services and goods ofbasket year -base ofCost yearcurrent in services and goods ofbasket year -base ofCost CPI ×=100Basket ofCost Basket ofCost CPIpricesyear basepricescurrent ×=Chapter 19: Measuring the Price Chapter 19: Measuring the Price Level and InflationLevel and Inflation99Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved. Monthly Household Budget of the Monthly Household Budget of the Typical Family in 1995 (Base Year)Typical Family in 1995 (Base Year)ItemCost (in 1995)Rent, two-bedroom apartment $500Hamburgers (60 at $2.00 each) 120Movie tickets (10 at $6.00 each) 60Total expenditure $680Constructing a Hypothetical CPIChapter 19: Measuring the Price Chapter 19: Measuring the Price Level and InflationLevel and Inflation1010Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved. Cost of Reproducing the 1995 (BaseCost of Reproducing the 1995 (Base--Year) Year) Basket of Goods and Services in Year Basket of Goods and Services in Year 20002000ItemCost (in 1995)Rent, two-bedroom apartment $630 $500Hamburgers (60 at $2.50 each) 150 120Movie tickets (10 at $7.00 each) 7060Total expenditure $850 $680Cost (in 2000)Constructing a Hypothetical CPI%25680170806680508 Living ofCost in Change ==−=Chapter 19: Measuring the Price Chapter 19: Measuring the Price Level and InflationLevel and Inflation1111Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved. The Consumer Price Index: The Consumer Price Index: Measuring the Price LevelMeasuring the Price LevelConstructing the CPIConstructing the CPI––Bureau of Labor Statistics (BLS)Bureau of Labor Statistics (BLS)Pick a base yearPick a base yearConduct the Conduct the consumer expenditure surveyconsumer expenditure surveyto to determine the basedetermine the base--year basket of goods and year basket of goods and