These allow us to reduce complicated statistical changes down to one single number.

Example: CPITakes prices for a large ‘bundle’ of goods

and calculates an index number that gives good indication of prices and whether inflation or deflation is occurring.

Assume that the economy only produces and consumes one good (food). Assume that this food is traded at the following prices each day

Day Price $

Monday 3

Tuesday 6

What can we say about the general price level?

It has doubled!!

What if there were two types of goods? (food and capital goods)

Day Prices

Food Capital Goods

Monday 3 4

Tuesday 6 7

What can we say now about the general price level?

Not so easy now to comment about the general price level…… this is why we use a price index.

Index

An index requires a base period, so that we can make comparisons from this period to the next We will make Monday our base period

The base year is always given an index value of a one with some zeros after it

We will choose 100 for this index

Now what would the index number have to be on Tuesday to tell us at a glance that prices have doubled?

100

200

This MUST be done from the base year:Step one- calculate the percentage change

in price from the base year (difference/original × 100)

Step two- use this percentage value to adjust the index value from the base (usually 1000) How do we do this?

If we have a base value of 1000, this is the same as 100.0. If we get a % change from the base year of 5.6 %, we add this to 100.0 and take away the decimal point. E.g. 100.0 + 5.6 = 105.6 = 1056

Inflation is calculated from one period to the next (NOT FROM THE BASE YEAR!).

This means we need to use our percentage change formula% change =

e.g.

100old

oldnew

YearYear IndexIndex InflationInflation

20072007 10451045 --

20082008 10721072 (1072 – 1045)(1072 – 1045) × 100× 100

10451045

20092009 11061106

Most common weighted price index used to calculate inflation.

The CPI is calculated four times per year (quarterly) and results from household surveys conducted by Statistics NZ on a regular basis.

Prices for a basket of over 700 goods and services are surveyed regularly and in a number of area’s in NZ.

These goods are decided upon as to what the ‘average’ NZ household purchases E.g. in 1990 a discman may have been included, BUT in

2009 an ipod would more likely be included instead.

The consumer price index uses a weighting process.

Each item in the CPI has a different influence

over the final score depending on its importance to families. This is determined by the fraction of their total spending on that item.

E.g Families typically spend about 17% of their income on “Food and beverages”. So the food and beverages make up about 17% of the final CPI index.

Good Quantity Purchased

Month one Month two Month three

Cheese (1kg block)

4 $12.00 $11.00 $12.50

Newspaper 30 $1.20 $1.50 $1.60

Topup card (cell ph)

1 $10.00 $10.00 $10.00

TOTAL expenditure

(Q×P)

Price Index (calculated from base year)

Rate of Inflation

(calculated from previous period)

Price per unit

It fails to include prices for goods that are difficult to measure, e.g. second hand goods

Measures changes in retail prices as they affect the average household… BUT what is the average household?

Spending patterns are constantly changing (because our income, tastes and fashions are constantly changing, new goods coming into the market) which creates a problem with weighting various categories of goods and services

Many goods change in design, quality and performance (with ever changing technology), e.g. the computer market- computers and laptops are constantly being improved.

It’s an acceptable internationally comparable statistic BUT other countries weightings, basket of goods, and review periods may differ.

Producer price index: measures inflation via the costs of production. The PPI inputs are such things as electricity, fuels, materials, etc

Food price index : A measure of the rate of price change of food and food services purchased by households

Capital goods price index (CGPI): measures inflation in terms of capital goods (investment goods= used to make other goods and services) e.g. office and accounting machinery, ovens, vehicles, etc.