Price-Level Changes

Review section 2 of the Macroeconomics chapter assigned in Unit 2.1, which defines and discusses the concept of Inflation. Learn what hyperinflation and deflation are and identify the method of calculating inflation. Pay attention to the meaning and calculation of the term "Price Index" and the way it is used to calculate inflation.

Price Indexes

Computing the Rate of Inflation or Deflation

The rate of inflation or deflation is the percentage rate of change in a price index between two periods. Given price-index values for two periods, we can calculate the rate of inflation or deflation as the change in the index divided by the initial value of the index, stated as a percentage:

Equation 5.4

Rate of inflation or deflation = percentage change in index / initial value of index

To calculate inflation in movie prices over the 2011–2012 period, for example, we could apply Equation 5.4 to the price indexes we computed for those two years as follows:

Movie inflation rate in 2012 = ( 1.06 − 1.00 ) / 1.00 = 0.06 = 6%

The CPI is often used for calculating price-level change for the economy. For example, the rate of inflation in 2011 can be computed from the December 2010 price level (2.186) and the December 2011 level (2.263):

Inflation rate = ( 2.263 − 2.186 ) / 2.186 = 0.035 = 3.5%