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5.2

5.2. CONSUMER PRICE INDEX. DEFINITION: Consumer Price Index (CPI) is. is a measure of general price level of goods and services in an economy as compared to the base year .

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5.2

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  1. 5.2 CONSUMER PRICE INDEX

  2. DEFINITION:Consumer Price Index (CPI) is • is a measure of general price level of goods and services in an economyas compared to the base year. • Base year= a selected year for reference,which is a nice and fine period without inflation or recession or disasters. • Sometimes known as cost-of-living index.

  3. MANY INDEXES MEASURED: other than Consumer Price Index (CPI), EXAMPLES: • HOUSE INDEX • IMPORT INDEX • STOCK PRICE INDEX • PALM OIL PRICE INDEX • RUBBER PRICE INDEX • INDUSTRIAL PRODUCTION INDEX • PRODUCER PRICE INDEX

  4. CONSUMERPRICE INDEX (CPI) • is measured by the current year average cost or price of a “consumer basket of goods” as a percentage of the cost or price of the same consumer basket of goods in a base year.

  5. The importance of CPI as an economic indicator • to measure the general price level in the economy as compared to the base year. • to measure the changes in the value of money. • to determine the growth rate and development of a country.

  6. 3 steps in Constructing CPI • Select goods and services which will represent consumer’s expenses by consumers which includes onlyconsumer goods and services in its consumption basket, in order to determine the effect of an increase in price on the consumers.CPI does not consider items purchased by business investments and government. • Weighting the figures to measure the importance of each goods in terms of the money the consumer spends on each product on the list.Usually, important goods and services will have a greater influence over the price index. • Select the base year or period of reference.

  7. A simple price index, CPI formula CPI = Current year consumption basket price X 100 Base Year consumption basket price P1 100 = X P0

  8. Example 1: Calculating CPI (without weight given) • Assuming 2000 as the base year: • Calculate the simple CPI for year 2007 for all the 4 goods. • Calculate the general price index or average CPI for year 2007.

  9. Solution to Example 1: CPI = P1 X 100 P0 CPI2005 = CPIF + CPIC + CPIT +CPIE 8.00 50.00 20.00 200.00 X X 100 + X 100 100 = + + X 100 5.00 30.00 16.00 150.00 = ( 160 +166.7 +125 +133.3 ) = 146.3 4 General / Average Price Index for year 2005

  10. Weighted CPI WCPI = Current Year basket consumption cost / price Weightage Value X100 Base Year basket consumption cost / price P1 100 X W = P0

  11. Constructing the general / average WCPI WCPIN = WN P1 X 100 P0 N (for each good) General WCPI= Total Weighted Price Index of consumption basket Total Weight PI X 100 WN PIN ∑ WN P0 N = ∑ = W ∑ W W1PI1 +W2PI2 +W3PI3 + …… + WNPIN = W1 + W2 + W3 + …………..+ WN

  12. Example 2 :Calculating WCPI (when weightage is stated) • Compute the WPI for each item in the year 2007. • Compute the general WPI for 2007. • Compute the percentage change in the price level between the base year and 2007. • Calculate the change in value of money between the base year and 2007. • Calculate the real value of money in the current year.

  13. Solution to Example 2: (i & ii) ∑ WNPIN WCPI = ∑W 20.00 200.00 8.00 50.00 + 100 X 100 + 3 X 2 X X + 1 X X 100 4 X X 100 150.00 16.00 5.00 30.00 GWPI = 4+3+2+1 640 + 500 + 250 + 133.3 152.3 = = 10 General Weighted Price Index for year 2007

  14. CPI is used to measure Inflation Inflation Rate = % change in prices or CPI = Current year PI – Base year PI Base Year PI = CPI1 – CPI0 CPI0 100 X X 100 (% Change in General Price Level)

  15. Inflation rate = % change in the general price level iii. Compute the percentage change in the price level between the base year and 2007. = CPI1 – CPI0 CPI0 =152.3 – 100 100 = 52.3 % 100 X X 100

  16. Changes in the Value of Money % ∆ Value of Money = 100 – General Price Index of base year (PI0) X 100 General Price Index of current year (PI1) Real Value of Money = PI0 PI1 (as inflation rises, value of money falls. X 100

  17. iv) Calculate the change in the Value of Money between the base year and 2007. Changes in the value of money = 100 – PI0 x 100 PI1 = 100 – 100 x 100 152.3 = 100 – 65.7 = 34.3% Because of inflation (or higher prices) the value of money falls by 34.3%.

  18. v) Calculate the real value of moneyin the current year. Real value of money = PI0 x 100 PI1 = 100 x 100 152.3   = 65.7

  19. Example 3: Given the following information of consumer price indexes for an economy in the years between 2000-2003. Calculate the percentage change in the general price level (inflation rate) for the followings: a)between the year 2001 to 2002 b)between the year 2002 to 2003.

  20. Solution for Example 3: Inflation rate: a)between the year 2001 to 2002 105 – 100 X 100 = 105 – 100 = 5% 100 b)between the year 2002 to 2003. 103 – 105 X 100 = – 2 X 100 = – 1.9% 105 105 (deflation)

  21. Exercise1: Let’s Try This! • Assuming 2003 as the base year: • Calculate the simple CPI for year 2007 for all the 3 goods. • Calculate the general price index or average CPI • for year 2007.

  22. Solution to Exercise 1: CPI = P1 X 100 P0 CPI2006 = CPIB + CPIF + CPIS 6.50 55.00 27.00 = + X 100 + X 100 X 100 4.50 35.00 15.00 = (144.44 + 157.14 + 180) = 160.53 3 General / Average Price Index for year 2007

  23. Exercise 2 : LETS TRY THIS! • Assuming 2003 as the base year: • Calculate WCPI for all the 3 goods in the year 2007. • Calculate general or average WCPI for year 2007.

  24. Solution to Exercise 2: ∑ WN PIN WCPI = ∑ W 27.00 55.00 6.50 + + 1 X X 100 2 X X 100 3 X X 100 15.00 35.00 4.50 = 2+3+1 288.88 + 471.42 + 180 = = 156.72 6

  25. Formula to calculate Real GNP or Real Income Price Index Year 0 or Base Year (PI0) Real GNP (Year 1) Nominal GNP (Year 1) = X Price Index Year 1 or Current Year (PI1) rGNP = nGNP X PI 0 PI 1 rY = nY X PI 0 PI 1

  26. Example 4:How to convert the nominal GNP to real GNP ? YearNominal GNPPrice IndexReal GNP 2000 RM345,788 million 100 2003 RM550,100 million 135 2007 RM875,570 million 159

  27. Solution for Example 4:How to convert the nominal GNP to real GNP? YearNominal GNPPrice IndexReal GNP 2000 RM345,788 million 100 2003 RM550,100 million 135 2007 RM875,570 million 159 RM345,788 mil RM407,481.5 mil RM550,672 mil

  28. Rate of growth (g): Real GNP Year 1 – Real GNP Year 0 g X 100 = Real GNP Year 0

  29. Example 5: • Given year 1995 as base year. GNP for 1995 is RM5,100 million. Assuming Consumer Price Index for year 2002 is 112 and GNP for 2002 is RM6,110 million. Based on the above information: • a)Calculate Real GNP for the year 2002 • b)Calculate the growth rate between the year 1996 to 2002.

  30. Solution to Example 5: a)Real GNP for year 2002 = 6,110m X 100 112 = RM5, 455.36 million b) g = (5455.36 – 5100) X 100 5100 = 6.96%

  31. Problems arise in constructing CPI • Goods and services selected sometimes do not represent the real consumers expenditure • The base year selected may sometimes be inaccurate • Involved time-lag • Price index is just a general picture on what really happened to the general price level • The weight given to each commodity might not represent the exact consumer preference.

  32. Question to Ponder (3): LET’S TRY THIS!Calculating WCPI • Taking 1995 as the base year. Calculate the weighted price index for 1998. • Calculate the percentage change in the general price level between 1995 and 1998. • Calculate the percentage change in the value of money between 1995and 1998.

  33. Solution to Question To Ponder (3): ∑ WNPIN WCPI = ∑W 27.00 300.00 6.50 55.00 + 100 X 100 + 3 X 2 X X + 1 X X 100 4 X X 100 15.00 250.00 4.50 35.00 GWPI = 4+3+2+1 577 + 471 + 366 + 120 153.4 = = 10 General Weighted Price Index for year 1998

  34. c. % change in the value of money = 100 – PI0 x 100 PI1 = 100 – 100 x 100 153.4 = 100 – 65.2 = 34.8%

  35. THANK YOU. Have A Nice Day! For The Next Class; Try To Answer ALL “Questions To Ponder” from Q4 to Q8 AND Model Questions (page 117: Q10, Q14 and Q15)

  36. THANK YOU. THAT’S ALL FOR TODAY

  37. ECO 210 / MAR 2002 The following table shows the price index of 4 types of goods for 2 different years • Which year is the base year? Give your reason. • Comment on the changes in the price of clothes between 1996 and 1998. • Calculate the weighted price index for each of the goods in both years. • What had happened to the general price level between the two years. • What are the types of goods would you include in your calculation of price index?

  38. ECO 211 / SEPT 2002 The table below shows the value of nominal GNP and price index for a country for 3 years. • Calculate the real GNP for year : • i) 1999 • ii) 2000 • iii) 2001. • b) Calculate the rate of economic growth between years:. • i) 1999 – 2000 ( based on real GNP) • ii) 2000 – 2001 ( based on nominal GNP).

  39. ECO 108 / APR 2001 The following table shows the prices for 3 types of goods for the year 1990 and 1995 Given the base year as 1990, answer the following questions: • Calculate the weighted price index for 1995 • Calculate the inflation rate between 1990 and 1995. • Explain three problems that occur in the construction of the consumer price index.

  40. ECO 108 / APR 2001 Use this information to answer the following questions • Calculate the real GNP for year 1998 and year 1999. • Calculate the nominal GNP per capita for 1999. • Calculate the percentage change in real GNP between 1998 to 1999

  41. ECO 110 / APR 1999 The following table shows the national income data for a country from 1990 to 1994. With the information given, complete the table

  42. ECO 211 / MAY 2004 a) The following table contains the information about a consumption basket of a country. The year 2000 is assumed to be the base year i)Find the ‘weights’ assigned for each good ii) What is purpose of assigning weights to the goods. iii) Calculate the general weighted price index for 2001. iv) If consumers’ incomes remained unchanged, what has happened to the standard of living in 2001. b)Use the information in the following to answer the questions that follow • Calculate the missing values in the above table • Find the economic growth rate between 2001 and 2002

  43. Multiple Choice questions • The rate of economic growth is best defined as • A. increase in investment as a % of GDP over time B. % increase in nominal GDP over time • C. % increase in real GDP overtime D. a % increase in the general price level over time • If the consumer price index (CPI) is rising more slowly than the national income, then • A. the real national income is increasing B. the real national income is decreasing • C. the real national income is not affected D. none of the above • The table below shows the CPI od a country for 4 consecutive years • YearCPI • 1 100 • 2 110 • 3 120 • 4 124 • The rate of inflation from Year 3 to Year 4 is • A. 3.33% B. 3.64% • C. 4% D. 24%

  44. Real GDP and nominal GDP are different because real GDP • A. Includes the effect of employment changes in the economy B. Includes the effects of trade deficits • C. Has been adjusted for changes in the price level D. Excludes net exports and personal income tax • 5. The value of output measured in constant dollars is known as • A. GNP at factor cost B. Nominal GNP • C. Real GNP D. GNP at market price • If CPI was 125 in year 1999 and 130 in year 2000, then the rate of inflation from 1999 to 2000 was • A. 3 % B. 4 % • C. 3.8 % D. 5 % • Real GDP in 1995 was RM8,200 million. In year 2000 real GDP had increased to RM10,500 million. The growth rate in real GDP between 1995 to 2000 was • A. 21.9 % B. 28.0 % • C. 18.0 % D. 20.0 %

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