Measuring Inflation

Inflation

Question #1: Why do people have so much spare change lying around these days? Why don’t they use it to buy valuable goods and services? How can this behavior be explained? ______

Measuring Inflation

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CPI in a given month = x 100

Cost of market basket in base period

Candy Auction

Directions: Several pieces of candy are going to be auctioned off today in class. There will be two rounds. Whoever offers the highest price in each round will win. All bids must be in full dollar amounts.

3. What would the base year CPI be?

4. What does this tell us, in general, about prices in this simulation?

Now that we know the CPI, we can calculate the inflation rate. Use the formula on the board to calculate this rate.

5. Inflation Rate for Candy Simulation:

Defining Inflation

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Costs of Inflation

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Causes of Inflation

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Complete the examples below:

Question #1: Imagine a situation where most of your income is spent on food, specifically hamburger. You earn $10 per day, and you spend $5 on hamburger. What percent of your income is spent on hamburger? ______Question #2: Next, imagine that all prices double. You are an average person in the economy, so when the average price level doubles, your income also doubles. Hamburger prices also will double. What percent of your income is spent on hamburger? ______Question #3: Are you richer or poorer as a result of inflation? ______

The Rest of the Story

What has happened to the value of each dollar you hold?

In Question #1, how much hamburger did $1 buy? ______

In Question #2, how much hamburger did $1 buy? ______

What has happened to the purchasing power of each dollar bill? ______

Inflation Myth- Inflation Makes You Poor

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Deflation And Its Effects

Example Problems

For this example, suppose our basket of goods consists of only three items: shirts, pants and bread with the following prices and quantities in 2006 and 2007. The base year will be 2006.

What is the total cost of the market basket in 2006?

What is the total cost of the market basket in 2007?

Using 2006 as the base year, what is the CPI in 2007?

Using 2006 as the base year, what is the CPI in 2006?

How much more did the market basket cost in 2007 than in the base year?