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One of the macroeconomic goals is price stability. It means that the average price level remains relatively stable. Price level is a weighted average of the prices of all good and services. A price index provides us with a reliable estimate of the price level. The most common price indices adopted by economists are: consumer price index and GDP deflator. Consumer Price index (CPI) tracks the prices of a representative market basket of consumer goods. CPI = (Total dollar expenditure on market basket in current year/ Total dollar expenditure on market basket in base year) X 100 Base year is a benchmark year that serves as the basis for price comparisons. The CPI compares the current prices of the market basket to the prices of those goods in base year. A simple example of CPI computation is illustrated in your textbook. Real value of an economic variable can be found using the CPI (or any price indexes). Nominal dollar income or dollar prices in different years can be compared using the real value concept. Real value = (Nominal value / CPI) X 100
Inflation is a rising general level of prices. It is an economic instability, which the U.S. government has to face. Inflation rate = [(current year’s price index – last year’s price index) / (last year’s price index)] X 100% Rule of 72 is a short cut for calculating the time it takes for the price level to double. # of years for price level to double = 72 / inflation rate. For example, recent inflation rate is about 3%, then the number of years for the price level to double is about 24 years. (72/ 3 = 24)
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