Measuring Inflation

Objectives

Explain index numbers.
Construct a simple weighted price index.
Explain how inflation is measured.

Inflation is an increase in the general price level, which means we need to find a way to incorporate all individual prices.

To help us to compare the price of different goods and even to compare price changes between years we use index numbers.

How is inflation measured in New Zealand?

There are a number of different methods. The most common one is

The Consumers Price Index (CPI)
The Consumer price Index is compiled by the Department of Statistics. It is an index that measures inflation in New Zealand.

Other methods include:

Capital Goods Price Index, measures the change in price of capital assets bought by producers e.g. ovens, buildings etc.
Farm Expenses Price Index, measures the change in input costs for NZ farming industry. E.g. fertiliser, dip, drench etc.
Food Price Index, measures the change in price of food.
Labour Cost Index, measures the change in price of labour costs or wages.
Producers Price Index measures the changes in the general level of prices for the productive sector e.g. raw materials, fuels and electricity.

What is the CPI?

The simplest way to think of the CPI is as a measure of the total cost of goods and services purchased by New Zealand consumers. Price changes of particular goods and services will alter the total cost. The Consumers Price Index measures this change over time.

The CPI measures the changing cost over time of the goods and services purchased in New Zealand in a specified base period by private, New Zealand-resident households.

Where possible, prices are collected for exactly the same goods and services each period. This ensures that changes in the cost of the goods and service ices shown by the CPI are not due to changes in the quantity or quality of the goods and services purchased. The CPI reflects only "pure" price changes.

How the CPI is organised?

Classification The goods and services covered by the CPI are classified into nine groups, 21 sub-groups and 69 sections, so that similar goods and services are grouped together.
Nine Groups
The nine groups in the New Zealand CPI are:

Food
Housing
Household Operation
Apparel
Tobacco Products and Alcoholic Drinks
Transportation
Personal and Health Care
Recreation and Education
Credit Services.

21 Sub-Groups The 21 published sub-groups are:

fruit and vegetables
meat, fish and poultry
grocery food, soft drinks and confectionery
meals away from home and take-away food
welling rentals
home ownership
energy
household appliances & furnishings
household supplies and services
clothing
footwear
public transport
private transport
cigarettes & tobacco
alcoholic drinks
personal goods and services
health care
stationery, books, magazines and newspapers
leisure and recreation
education and child care
financial & credit services charges. Consumers Price Index Base: June 1999 Quarter (=1000)

The different groups in the CPI are weighted this means that

the prices of goods and services on which consumers spend relatively more of their total expenditure have the greatest influence, on the CPI, the index is calculated using weights.

Expenditure on a particular good or service as a proportion of total household expenditure is calculated, to give the relative importance or “weight” of that item in the CPI.
Since some items are relatively more important in overall expenditure when compared to other we weight items based upon their relative importance. More important / purchased items are given a higher weighting and less important items are given a lower rating.

Revisions of the CPI

The CPI is reviewed on a major basis every three years.

This is to ensure that the goods and services being surveyed are still relevant - have new goods or services come into existence?

Do the weightings reflect what is actually reflect current household expenditure?

Limitations of the CPI

The CPI is designed to provide only a broad measure of price changes which effect households.

Therefore, the CPI has limitations in that it:
The rate of inflation calculated by the CPI is unlikely to be the actual rate of inflation experienced by any real individual or household because it is an average.
The CPI is reviewed every 3 years and so is unlikely to match current expenditure patterns especially toward the end of the three year period. Problems include
new products e.g. internet charges were not included until 1999.
- products that change in popularity or usage.
It can be difficult to allow for the change in quality of products over time. E.g. computers.
is not a cost-of-living index
does not measure consumer satisfaction
cannot be expected to reflect the price changes experienced by any one consumer
does not include investment-related goods and services purchased by households

Constructing a weighted price index.

In the table below to obtain total expenditure all we need to do is multiply the weight times the price of the commodity at each year level.
Once this is done for each of the year levels we then need to calculate total expenditure for each of the years.

		Prices			Total Expenditure
Commodity	Quantity purchased / No	Year 1	Year 2	Year 3	Year 1	Year 2	Year 3
Potatoes (5 kg)	5	1.00	1.20	1.30	5.00	6.00	6.50
Hoki Fillets (1 kg)	2	15.00	14.50	14.50	30.00	29.00	29.00
Apples (1 kg)	4	2.00	2.20	2.50	8.00	8.80	10.00
Total Expenditure					43.00	43.80	45.50

Once the total expenditures for each of the year levels is calculated we then need to calculate the percentage changes.

Year 1 - 2 Percentage change = 43.80 - 43.00 / 43.00 x 100

= 0.80/43.00 x 100

= 1.86%

Year 1 - 3 Percentage change = 45.50 - 43.00 / 43.00 x 100

= 2.50/43.00 x 100

= 5.81%

Once the percentage change is calculated we can then calculate the index number.

Year	Consumer Price Index (CPI) Base Year = 1000	Rate of Inflation
1	1000	n/a
2	1019	1.9
3	1058	5.8

The percentage change numbers need to be rounded in order for them to fit into the index.