Question

CPI Inflation

1. As the aftermath of the COVID-19 pandemic, many people in the world have experienced a decrease in income. Do you think consumer price index will be lower or higher this year? Explain why? Also, comment if you consider the officially reported value of inflation will be objective. What economic concepts support your answer?
2. During the financial crisis of 2008 -2009 CPI in the USA decreased dramatically. What can explain such a decrease? What elements of the CPI basket were affected by the crisis and why? How do you think the CPI will change in 2020?
3. Consider an economy. Government has measured inflation in this economy in the recent year using two methods: CPI method and the DGP-deflator method. The results showed that CPI inflation was higher than GDP-deflator measured inflation. How can you explain this? Support with theory and examples.

Answer 1

As the aftermath of the COVID-19 pandemic many people in the world have experienced a decrease in income. Do you think consumer price index will be lower or higher this year? Explain why? Also, comment if you consider the officially reported value of inflation will be objective. What economic concepts support your answer?

Consumer price index (CPI) is a measure of inflation and inflation is directly affect by production cost and AD. If the production cost or AD (mainly consumption) increase its increase price level that boost inflation and vice-versa. But during this pandemic, people have lost their jobs and they are very uncertain about future. The economy has shrunk worst and future forecast is not good also. So these factors has decreased consumer's confidence level and it will negatively affect the consumption level. So, i think consumer price index will be lower this year. Accoding to the AD-AS model when AD incraese output and price level incraese and vice-versa. AD is directly affected by the consumption, investment, government spending and net export. Here consumption contribute for 61% in AD. Decreasing AD is the main reason of recession and this time the economy is performing worst after 2008-09 crisis. So, Due to this COVID-19 crisis the CPI will will be lower this year. You can see in the statistical data of the USA, the CPI has decreased rapidly scince Feb-2020 and this time it is at 0.3% and the economy is facing a situation of deflation.

During the financial crisis of 2008 -2009 CPI in the USA decreased dramatically. What can explain such a decrease? What elements of the CPI basket were affected by the crisis and why? How do you think the CPI will change in 2020?

Accoding to the AD-AS model when AD incraese output and price level incraese and vice-versa. AD is directly affected by the consumption, investment, government spending and net export. Here consumption contribute for 61% in AD. Decreasing AD were the main reason in 2008-09 crisis. So, During this COVID-19 crisis the CPI will will be lower this year. When AD decrease its decrease output and price level and decreasing price level decraese AS (production level). decreasing production level increase unemployment and decrease income level and decreasing income level decrease consumption level because now spend less due to income loss or low income. Decreasing consumption and investment decrease AD and decreasing AD decrease output and price level and economy get inter into a recession. So, we seen that how decreasing AD decraese price level or inflation (CPI). Because during the recession CCI and income level decraese rapidly and consumer spend les so, CPI decraese and during the 2008-09 crisis, CPI decrease due to these reasons. I think this time the economy is facing the same situation and major indicators like CCI, GDP growth rate, inflation decraese rapidly nad other side the unemployment, fiscal deficit is very high. So, i think consumer price index will be lower this year.

Consider an economy. Government has measured inflation in this economy in the recent year using two methods: CPI method and the DGP-deflator method. The results showed that CPI inflation was higher than GDP-deflator measured inflation. How can you explain this? Support with theory and examples.

CPI -

The Consumer Price Index (CPI) is a measure changes in price level of the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care.

CPI = CPI= (Year Cost of Market Basket in Current Year​/Cost of Market Basket in Base Year)*100

GDP Deflator

Deflation is when the general price levels in a country are falling as opposed to inflation when prices rise.

GDP Deflator = (Nominal GDP/Real GDP)*100 or Nominal GDP/Price Index

Example: USA

Real GDP = $17.3 trillion

Nominal GDP = $19.5 trillion

GDP Deflator = ($19.5/$17.3)*100 = 112.71

CPI = 258.44

So you can see both are different for the US.