Published on 16 Oct 2011

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Econ 102 Chapter 6 Notes Prof: Angela Trimarchi

Chapter 6: Measuring the Cost of Living

Inflation : A rise in the overall level of prices

Deflation : A fall in the overall level of prices

Disinflation : A decrease in the rate of inflation

Econ 102 Chapter 6 Notes Prof: Angela Trimarchi

4 steps to constructing a price index:

1. Fix the Basket

2. Find the Prices

3. Compute the Basket’s Cost

4. Choose a Base Year and Compute the Index

Compute the Inflation Rate

Calculation of a Price Index

Consumer Price Index =

Cost of a fixed basket in current year * 100%

Cost of a fixed basket in base year

Macroland example:

1990 1991

Quantity Price Quantity Price

Milk (bags) 160 $1.10 150 $1.20

Compact Discs (#) 5 $15.00 10 $16.00

Cost of basket in base year (1990):

= Pmilk1990 (Qmilk1990) + PCD1990(QCD1990)

= $1.10(160) + $15.00(5)

= $251

Cost of basket in the current year (1991):

= Pmilk1991 (Qmilk1990) + PCD1991 (QCD1990)

= $1.20(160) + $16.00(5)

= $272

CPI1991

= $272 * 100

$251

= 108.37%

Question One:

If the CPI in Year 1 is 125 and the CPI in year 2 is 150, calculate the

inflation rate.

Answer:

20% - Measured by the percent change in the CPI

Formula for Percentage Change: