Effects of Unemployment:
-Economic Problems (loss of output/loss of skills)
-Immense human suffering (illness, breakdowns)
-Social Problems (homelessness, crime)
-The average level of all prices in the economy
-The rate (%) at which the price level is changing
Consumer Price Index (CPI):
-The most common measure of the price level
-Based on the price of a typical consumer “basket” of goods and services (urban
-CPI for the BASE PERIOD is always set to 100.
In later/following years, the CPI shows prices as a ratio of the price in the
In the economy of ultimate pleasure, the typical urban household consumes the
following goods & services…
Base Year Current Year
Goods Quantity Price ($) Expenditure Price ($) Expenditure
Chocolates 100 10 1,000 15 1,500
Ice Wine 50 50 2,500 60 3,000
Back Rubs 70 30 2,100 30 2,100
Total 5,600 6,600
a) What is the value of expenditures in the base year and in the current year?
Base Year = $5,600
Current Year = $6,600
*CPI IN THE BASE YEAR IS ALWAYS 100*
b) Find the value of the CPI in the current period.
Current CPI = (6,600/5,600) x 100 = 117.857 = 117.86
c) What is the inflation rate between the base and current years?
Inflations Rate = (P2 – P1/P1) x 100
= (117.86 – 100/ 100) x 100 = 17.86 %
The CPI is a fixed base weighted index number.
The CPI in the current year is 117.86
Prices rose (inflated) by 17.86 % from the base year to the current year
d) Have the relative prices changed?
Yes, the price of chocolate has increased by 50%.
= ((15-10)/10) x 100 = 50%
Yes, the price of ice wine has increased by 20%
= ((60-50)/50) x 100 = 20%
The price of back rubs has stayed the same.
-The percentage of change in the CPI
-Usually calculated over a year (the annual inflation rate).
IR calculated between any 2 years…
e.g. ((P2-P1)/P1) x 100
CPI in Jan 1995 = 131.9
CPI in Jan 1996 = 135.2
What is the percentage change in the CPI from 1995 -1996?
= ((135.2 – 131.9) / 131.9) x 100
= (3.3/131.9) x 100
= 0.025 x 100
Price level rose 2.5% between January 1995 and January 1996. The inflation rate
Effects of Inflation:
- The dollar is the financial yardstick
Purchasing power of the dollar changes with inflation
-[M/P] where M= Nominal Dollar and P= Price Level
i.e. The real value of the dollar changes with inflation
-Inflation changes value of any sum that is fixed in NOMINAL terms [M].
Fully Anticipated Inflation:
-If included in all financial contracts, inflation has no real effects
Unanticipated Inflation: -Benefits those with an obligation to pay money (borrowers).
-Harms those who are entitled