Question

What is the Consumer Price Index (CPI) and how is it determined each month? How does the Bureau of Labor Statistics (BLS) calculate the rate of inflation from one year to the next? What effect does inflation have on the purchasing power of a dollar? How does it explain differences between nominal and real interest rates? How does deflation differ from inflation? (Answer in your own words)

Answer 1

Consumer Price Index is the main measure of inflation in It is used by the government to report inflation rates every month and every year. It is based on the price of a market basket of 300 consumer goods and services, reflecting the most recent patterns of consumer purchases. The BLS arbitrarily sets the CPI equal to 100 for 1982-84. The CPI for any particular year is given as price of the most recent market basket in the paticular year price estimate of the market basket in 1982-1984 Inflation decreases the purchasing of a dollar because a unit of dollar would get less of goods and services. The difference between nominal and real rate of interest is the expected rate of inflation. Moreover, higher the rate of actual rate of inflation, higher will be the expected rate of inflation Deflation means that the price level is falling, whereas with inflation overall prices are rising. Deflation is undesirable because the falling prices mean that incomes are also falling, which reduces spending, output, employment, and, in turn, the price level (a downward spiral). Inflation in modest amounts (3%) is tolerable, although there is not universal agreement on this point.