Economics

Chapter 2

General Price Level

General Price Level

General price level Weighted average of prices of all goods and

services. Shown by different price indexes

Price index A figure showing the price level of the same

basket of goods and services. Base period vs. specific period At base year, always set at 100

Consumer Price Index (CPI)

Price level of goods and services generally consumed by household.

Index Expenditure range % of household Price change faced by income group

CPI (A) $4,000-$15,499 50% Low

CPI (B) $15,500-$27,499 30% Medium

CPI (C) $27,500-$59,999 10% High

Composite CPI $4,000-$59,999 90% App. all household

Consumer Price Index (CPI)

HK Statistics: Base year = 2004-2005

Source: Table: Consumer Price Indices, Census and Statistics Department, Hong Kong (http://www.censtatd.gov.hk/hong_kong_statistics/statistical_tables/index.jsp?subjectID=10&tableID=52A)

Year / Month Composite CPI

CPI (A) CPI (B) CPI (C)

2005 annual 100 100 100 100

2009 annual 109.5 107.4 110.0 110.9

2010 annual 112.1 110.4 112.7 113.2

2011 (Mar) 116.8 116.4 117.0 116.7

2011 (Jun) 118.9 118.2 119.1 119.2

2011(Sept) 117.9 113.8 119.3 120.7

Calculate CPI

Year 2000 Year 2008

Year / Month Selling Price Expenditure Selling Price Expenditure

40 Shirts $10 $400 $12 $480

30 loaves of bread $20 $600 $30 $900

Total $1,000 $1,380

CPI of 2000 =

CPI of 2008 =

Example

Year 2009 (base year) 2010 2011

Price Exp. Price Exp. Price Exp.

20 T-Shirts

$20 $400 $25 $500 $50 $1000

40 apples

$2.5 $100 $4 $160 $10 $400

Total $500 $660 $1400

CPI of 2009 =

CPI of 2010 =

CPI of 2011 =

The implicit price deflator of GDP

Also named as : GDP deflator

Measure the price change of all types of goods included in GDP.

Formula:

𝑰𝒎𝒑𝒍𝒊𝒄𝒊𝒕 𝒑𝒓𝒊𝒄𝒆𝒅𝒆𝒇𝒍𝒂𝒕𝒐𝒓 𝒐𝒇 𝑮𝑫𝑷=𝑵𝒐𝒎𝒊𝒂𝒏𝒍𝑮𝑫𝑷𝑹𝒆𝒂𝒍𝑮𝑫𝑷

𝒙 𝟏𝟎𝟎

The implicit price deflator of GDP

Year Nominal GDP ($) Real GDP ($) GDP deflator

2009 (base yr.)

1,000 1,000

2010 1,200 1,000

2011 1,600 1,350

CoverageCPI

Products consumed by household

Fixed basket of goods and services. (Same for diff. yrs)

Imports , Exports

Capital goods

GDP deflator

All products produced by an economy

Counting all GDP components: C + I + G + X - M.

Exports , imports

Capital goods (I)

Inflation

Definition:The persistent increase in the general price level.

Shown by CPI continuously.

Hong Kong Statistics:

Inflation rate =

Inflation rate =

Inflation rate = %

Deflation

Definition: The persistent decrease in the general price

level.

Inflation rate is negative

Inflation

Given the CPIs of Economy A

a. Find the inflation rate in 2009.b. Find the inflation rate in 2010.

Year CPI

2008 (Base year) 100

2009 110

2010 125

CPI vs. GDP deflator

Aim at

CPI

Change in the cost of living

Amount spent on basic living expenses

GDP deflator

Purchasing power of money

Amount of goods that can be bought with money

Purchasing power In 2009

A hamburger = $10 i.e. You can buy a hamburger if you have a $10 note

In 2010 A hamburger = $12

i.e. You can’t buy a hamburger with a $10 note

The purchasing power of the $10 note is lowered

Nowadays, the 10 cents coins have very little purchasing power

CPI - Overestimation

Substitution bias:

CPI Basket (Good A)

If Price of Good A Choose Good B (substitute)

Although CPI (Good A), people are not fully affected

Same living standard

CPI overestimate the increase in price level

CPI - Overestimation

Quality improvement:

Products with high technology (e.g. new mobile phone)

Buy same amount (same expense) better enjoy

or

Buy the same old model (less expense) same enjoy

CPI can’t reflect the change in enjoyment

Which price index is better? (Textbook p.60-61)

a. Calculate the inflation rates of 2004 and 2005.

Year Implicit price deflator of GDP

Inflation rate Composite CPI Inflation rate

2003 104 - 99.8 -

2004 100.3 - 3.6% 99.4 - 0.4%2005 100.3 0% 100.3 0.9%

Inflation rate of 2004 =

Inflation rate of 2005 =

Which price index is better? (Textbook p.60-61)

b. Describe the changes in inflation rates and cost of living with reference to the GDP deflator and Composite CPI.

Base on GDP deflator: a ______ inflation rate in 2004 suggests a ________ in the cost of living. a ______ inflation rate in 2005 showing that the cost of living

__________________. Base of Composite CPI:

a ______ inflation rate in 2004 suggests a ________ in the cost of living. a ______ inflation rate in 2005 suggests a ________ in the cost of living.

Year Implicit price deflator of GDP

Inflation rate Composite CPI Inflation rate

2003 104 - 99.8 -

2004 100.3 - 3.6% 99.4 - 0.4%2005 100.3 0% 100.3 0.9%

positve

negative

negative

zero

decrease

decrease

remains unchanged

increase

Which price index is better? (Textbook p.60-61)

c. Which index is a better indicator of inflation? Which index is a better indicator of the cost of living?

Inflation refers to ___________________________________________ As the ______________ measure price changes of a large scope of goods,

it is better indicator of inflation Cost of living refers to

___________________________________________ It is affected by price change in _________ goods only. Therefore, ________ , which includes only _________ goods, is a better

indicator of the cost of living.

Year Implicit price deflator of GDP

Inflation rate Composite CPI Inflation rate

2003 104 - 99.8 -

2004 100.3 - 3.6% 99.4 - 0.4%2005 100.3 0% 100.3 0.9%

A persistent increase in the general price level

GDP deflator

consumer

CPI

amount spent on basic living expenses

consumer

Which index is better?

GDP deflator

Prices change of a large scope of goods

Better for measuring inflation

CPI

Price change of consumer goods

Better for indicating living standard