Measuring Inflation

What is Inflation?
Inflation is a quantitative
measure of the rate at which
the average price level of a
basket of selected goods and
services in an economy
increases over a period of time.
It is the constant rise in the
general level of prices where a
unit of currency buys less than
it did in prior periods. Often
expressed as a percentage,
inflation indicates a decrease in
the purchasing power of a
nation’s currency.
Purchasing power is the value
of a currency expressed in
terms of the amount of goods
or services that one unit of
money can buy.
Inflation
 Inflation can arise from internal and external events.
 Some inflationary pressures direct from the domestic
economy, for example the decisions of utility businesses
providing electricity or gas or water on their tariffs for the year
ahead, or the pricing strategies of the food retailers based on
the strength of demand and competitive pressure in their
markets.
 A rise from VAT would also be a cause of increased domestic
inflation in the short term because it increases a firm’s
production costs.
 Inflation can also come from external sources, for example a
sustained rise in the price of crude oil or other imported
commodities, foodstuffs and beverages.
 Fluctuations in the exchange rate can also affect inflation –
for example a fall in the value of the peso against other
currencies might cause higher import prices for items such as
foodstuffs from Europe or technology supplies from the
United States – which feeds through directly or indirectly into
the consumer price index.

Causes of Inflation

1. Cost- push
It occurs when firms respond to rising cost by increasing prices in order to protect their
profit margin.

There are many reasons why costs might rise:

a. Component cost: e.g. an increase in the prices of raw materials and other
components. This might be because of a rise in commodity prices such as oil,
copper, and agricultural products used in food processing.

b. Rising labor cost: caused by wage increases, which are greater than
improvements in productivity. Wage costs often rise when unemployment is low
because skilled workers become scarce and this can drive pay levels higher.
Wages might increase when people expect higher inflation so they ask for more
pay in order to protect their real incomes. Trade unions may use their bargaining
power to bid for and achieve increasing wages, this could be a cause of cost-
push inflation.

c. Expectation of inflation are important in shaping what actually happens to

inflation. When people see prices are rising everyday items they get concerned
about the effects of inflation on their real standard of living. One of the dangers of

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Measuring Inflation

a pick-up in inflation is what the Bank of England calls “second round effects”
i.e. an initial rise in prices triggers a burst of higher pay claims as workers look to
protect their way of life. This is also known as a “wage- price effect.”

d. Higher indirect taxes – for example a rise in the duty on alcohol, fuels and
cigarettes, or a rise in Value Added Tax (VAT). Depending on the price elasticity
of demand and supply for their products, suppliers may choose to pass on the
burden of the tax onto consumers.

e. A fall in the exchange rate – this can cause cost-push inflation because it leads
to an increase in the prices of imported products such as essential raw materials,
components and finished products.

f. Monopoly employers/ profit-push inflation – where dominants firms in a

market use their market power (at whatever level of demand) to increase prices
well above costs.

2. Demand-pull
 It occurs when aggregate demand is growing at an unsustainable rate leading to
increase pressure on scarce resources and a positive output gap.
 When there is excess demand, producers can raise their prices and achieve bigger
profit margins.
 Demand-pull inflation becomes a threat when an economy has experienced a boom
with GDP rising faster than the long-run trend growth of potential GDP.
 Demand-pull inflation is likely when there is full employment of resources and SRAS
is inelastic.

What are the main causes of Demand-Pull Inflation?

a. A depreciation of the exchange rate increases the price of imports and

reduces the foreign price of a country’s exports. If consumers buy fewer imports,
while exports grow, AD in will rise – and there be a multiplier effect on the level of
demand and output.

b. Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or
higher government spending. If direct taxes are reduced, consumers have more
disposable income causing demand to rise. Higher government spending and
increased borrowing creates extra demand in the circular flow.

c. Monetary stimulus to the economy: A fall in interest rates may stimulate too
much demand – for example in raising demand for loans or in leading to house
price inflation. Monetarist economists believe that inflation is caused by “too
much money chasing too few goods” and that governments can lose control of
inflation if they allow the financial system to expand the money supply too
quickly.

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Measuring Inflation

d. Fast growth in other

countries – providing a
boost to exports overseas.
Export sales provide an
extra flow of income and
spending into the circular
flow – so what is
happening to the
economic cycles of other
countries definitely affects
the country.
References:
Terms to Remember:
 Monopoly – this is a market structure where
there is only one seller.
 Cartel – It refers to a group of people that
controls the price, production and distribution of
goods; an industrial combination in which
several different firms agree on some form of
joint action as in regulating prices and output in
some field.
 Devaluation – lowering a currency’s value
compared to other currencies by government
order.

https://www.tutor2u.net/economics/reference/inflation-causes-of-inflation
Reasons for Inflation

1. Monopoly/ Cartel – The hoarding of goods, which cause inflation, happens when the
market is controlled by a monopoly or a cartel.
2. Export Oriented – Since the main concern of business is profit, businessmen and
producers prefer exporting raw materials and other products rather than putting them in
the market for local consumption.
3. Import Depended – Other businessmen resort to imported goods instead of locally
made products.
4. Foreign Debt – We have this debt from the World Bank – International Monetary Fund.
A part of the national budget is intended for the payment of foreign loans.

People Who Benefit From Inflation

Several groups usually benefit during inflation:

1. People without Fixed Income

The incomes of individuals sometimes move in accordance with price change. Their
income may increase rapidly at a higher rate than that of inflation. Monopolist,
entrepreneurs, and investors, resource owners, and others are some of the groups who
earn more compared to the rate of price increase.

2. Debtors

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Measuring Inflation

Debtors benefit during a price increase particularly if interest rates of loans are lower
than the inflation rate.

For example, Christian borrowed 3,000 to buy one sack of rice, the money he borrowed is
payable within 12 months with 7 percent interest. It means that the 3,000 will become 3,210. But
if the inflation rate for the year is 15 percent the amount of 3,000 will become 3,450 to be able to
buy one sack of rice which Christian was able to buy at 3,000, though he has to pay 3,210. Still
he was able to benefit through borrowing and its amounts to 240.

3. Speculators
Businessmen who are inclined to buy products with unstable prices speculate that their
price can increase rapidly and easily.

Examples of this are land, jewelry, gold, and other precious stones. Whatever condition of the
economy the price of such products is increasing.

People Who Are Hurt From Inflation

A greater number of people lose their capacity to purchase their basic needs due to high prices.

1. Creditors
Individuals who give loans experience losses if there is inflation. The interest on loans
may not be enough to cover the price increase.

For example, if an individual borrowed 2,000 with six percent interest per month, and if the
inflation rate becomes 8 percent per month, the amount to be collected is insufficient on the part
of the creditor because it can only buy things in the amount of 1,960 instead of 2,120. This
happens because the inflation is higher than the interest rate of the loan.

2. Individuals who Save

Saving money is good and meaningful activity of man. But during inflation, the money in
the bank depreciates in value due to the low interest rate of the bank.

For example, Jaime saves 5,000 in the bank with 15 percent interest per year. After a year, the
amount of savings will become 5,750. With 15 percent interest rate per year, Jaime earns 15
percent more money in the bank. However, with 17 percent inflation rate, the real value of the
money after a year becomes 2 percent lower than the principal amount. Her money depreciates
in value due to higher inflation rate.

3. People with Fixed Income

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Measuring Inflation

Workers and employees like clerks, nurses, teachers, and others who receive a fix
income every month during a price increase are negatively affected by inflation. The
quantity of products and services they can buy decreases with every price increase.

Measuring the Price Increase

To be able to study the price change the government assigns and selects products to be
included in the market basket of goods, which is usually purchased by an average family of a
specific period of time. From the market basket of goods, a price index is formed. It represents
the total and average change in price of all commodities. The price index depends on what
commodities would be examined.

Instruments in Measuring Price Indices

1. General Wholesale Price Index (GWPI)

The general wholesale price index (GWPI) is an indicator used to measure the changes
in the price levels of commodities that flow into the wholesale trade intermediaries.

Wholesale price refers to the price of commodity transacted in bulk for further resale or
processing. It is the actual “spot” transaction price received by the wholesalers,
distributors or marketing agents for large lots but net of discounts, allowances and
rebates. It is the sum of the
producer price, wholesale
trade margin, tax mark-ups
and distribution cost of the Terms to Remember:
wholesaler.
 Depreciation – it refers to the decline in value of items
What are the uses of which occurs over a period of time.
GWPI?  Price Index – it is a number that compares the prices of
The index is a guide for the present year to the prices of the base year.
economic analysis and  Based Period – this is a reference date or simply a
policy formulation, and is convenient benchmark to which a continuous series of
used as basis for price index number can be related.
adjustments in business  Market Basket – this refers to sample commodities that
represents a large variety of commodities traded in the
contracts and projects.
market. The basket consist of locally and imported
goods for resale.
Specifically, wholesale price
 Cost of Living – is the amount of money needed to
index is used as a deflator purchase the basic necessities. It can be identified as
to express value series in the weight assigned in each item included in the basket
real terms. It measures the of goods by the household.
change in actual volume of
transaction by removing the
effects of price changes. It
may be used as basis for
forecasting business and
economic conditions.

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Measuring Inflation

2. General Retail Price Index (GRPI)

The general retail price index (GRPI) is a statistical measure of the changes in prices at
which retailers dispose of their goods to consumers or end-users relative to a base year.

What are the uses of GRPI?

The GRPI is an indicator used to monitor economic situation of the retail trade sector. It
is also used as a deflator of the National Accounts especially on the retail trade sector
and serves as a basis of forecasting business in the retail trade.

3. Consumer Price Index (CPI)

The consumer price index (CPI) is an indicator of the change in the average retail price
of a fixed basket of goods and services commonly purchased by households relative to a
base year.

What are the uses of CPI?

The CPI is most widely used in the calculation of the inflation rate and purchasing power
of the peso. It is a major statistical series used for economic analysis and as a
monitoring indicator of government economic policy.

The CPI is also used to adjust other economic series for price changes. For example,
CPI components are used as deflators for most personal consumption expenditures
(PCE) in the calculation of the gross national product (GNP). Another major importance
of CPI is its use as basis to adjust wages in labor management contracts as well as
pensions and retirement benefits. Increases in wages through collective bargaining
agreements use the CPI as one of their bases.

How is the CPI computed?

The CPI is computed using the weighted arithmetic mean of price relatives, a variant of
Laspeyres formula with fixed base year period weights.

The prices of the items included in the basket of goods are averaged to get the CPI.
Once the CPI is determined each year, it is compared to the price of the based year.

Example:

ITEMS 2014 2015

Rice 40.00 44.00
Milk 58.00 60.00
Bread 35.00 60.00
Cooking Oil 45.00 59.00
Eggs 115.20 125.00
Meat 225.00 258.00

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Measuring Inflation

Beverages 120.00 150.00

Tobacco 80.00 120.00
Miscellaneous 558.00 519.00
TOTAL 00 0.00
CPI 141.80 155.00

Interpretation:

The CPI of 2014 is 141.80 means the prices in 2014 were 141.80 percent of 2006
prices. Then, in 2015 prices were 155.00 percent of 2006. The CPI has increased as
shown in the table. Let us assume the CPI of 2016 is 160.20, it means on average, the
prices of 2016 were at about 160.20 percent of the level of prices of 2006.

The prices of the said goods and services are compared to the prices of the base year.
The base year is changing and is the year where the movement of price in the market is
normal. The CPI of the base year is always 100 percent.

Areas
Division Philippines NCR Outside
NCR
00 ALL ITEMS 100.00 23.79 76.21
FOOD AND NON-ALCOHOLIC
01 38.98 6.78 32.20
BEVERAGES
ALCOHOLIC BEVERAGES AND
02 2.00 0.33 1.66
TOBACCO
03 CLOTHING AND FOOTWEAR 2.95 0.74 2.22
HOUSING, WATER,
04 ELECTRICITY, GAS AND 22.47 6.97 15.49
OTHER FUELS
FURNISHING, HOUSEHOLD
05 EQUIPMENT AND ROUTINE 3.22 0.84 2.38
MAINTENANCE OF THE HOUSE
06 HEALTH 2.99 0.64 2.35
07 TRANSPORT 7.81 1.86 5.95
08 COMMUNICATION 2.26 0.71 1.55
09 RECREATION AND CULTURE 1.93 0.50 1.43
10 EDUCATION 3.36 0.76 2.61
RESTAURANT AND
11 MISCELLENEOUS GOODS AND 12.03 3.66 8.37
SERVICE
Weighs by Commodity Group for CPI (2006=100)
Reference: Primer on Consumer Price Index2_1_0. Philippine Statistic Authority

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Measuring Inflation

If you want to know how much the cost of a

particular goods in 2016 is compared to the Terms to Remember:
base year, multiply the price of a particular
good during the base year period to the CPI  Inflation Rate – shows the
of the current year. For example, dining table continuing increase in the general
set which costs 3,500 in 2006, will cost 5,607 price level.
in 2016.  Deflation Rate – refers to the
decrease in the general price level
of commodities in the market.
The computation is like this 3,500 x 1.602 = 5,607.
The 3,500 is the price of the dining table set in  Headline Inflation – it measures
2006, then multiply to the CPI of 2016, which is changes in cost of living based on
160.2 percent. So, the cost of the dining table set movements in the prices of a
is determined by using the CPI. specific basket of goods and
services. It refers to the annual rate
of change or the year to year
What is the Purchasing Power of the Peso?
change in the CPI.

The purchasing power of the peso shows how much

the peso in the base period is worth in the current
period. It is computed as the reciprocal of the CPI for
the period under review multiplied by 100.

Formula:

100
Purchasing Power of the Peso =
CPI

For example, if the base year is 2006 and the CPI for August 2016 is 160.5, the real value of
peso in August 2016 is 0.62 compared to the 100 of the base year. It means, there is a decline
in the purchasing power of the peso. The more CPI increases, the PPP decreases.

The CPI can be used to find the inflation rate, the annual rate of change in the CPI. The inflation
and deflation rate are based on the CPI of every month and year.

Computation of Inflation Rate

Formula:

CPI Current Year – CPI Previous Year

Inflation Rate = X 100
CPI Previous Year
OR
CPI Current Year
Inflation Rate = - 1 X 100
CPI Previous Year

INFLATION RATES
For periods indicated

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Measuring Inflation

(2012 = 100)
2014 2015 2016 2017 2018 2019
Average 3.6 0.7 1.3 2.9 5.2 2.5

January 3.7 1.5 0.7 2.5 3.4 4.4

February 3.6 1.5 0.5 3.1 3.8 3.8
March 3.5 1.5 0.6 3.1 4.3 3.3
April 3.6 1.4 0.7 3.2 4.5 3.0
May 4.0 0.9 0.9 2.9 4.6 3.2
June 3.8 0.6 1.3 2.5 5.2 2.7
July 4.2 0.2 1.3 2.4 5.7 2.4
August 4.2 0.0 1.3 2.6 6.4 1.7
September 3.9 -0.4 1.7 3.0 6.7 0.9
October 3.7 -0.2 1.8 3.1 6.7 0.8
November 3.0 0.3 2.1 3.0 6.0 1.3
December 1.9 0.7 2.2 2.9 5.1 2.5
Beginning March 6, 2018, the base year of the Consumer Price Index (CPI) was updated from 2006 to 2012. The
2012- based CPI uses the chain method, which allows the inclusion of new commodities in the market basket to
reflect changing consumer tastes and preference as well as technological changes. The chain method also allows
the exclusion of commodities as a result of obsolescence.

Source: Philippine Statistics Authority (PSA)

The table shows the inflation rate for six consecutive years in our country. The year 2015 has
the lowest inflation rate in our country. Having a double digit inflation is not good for the
economy as well as to the people because they cannot buy the things they need in their lives.

Effects of Inflation

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Measuring Inflation

More
High Prices
Production

High Wages/ More

Salaries Workers

Price increase may be viewed as a sign of progress in some economy. It motivates

businessmen to improve and increase their production.

If the price is high, more businessmen are motivated to invest for higher production and to set
up their own businesses. It helps decrease the unemployment rate of the country. And for
businesses that engage in labor- intensive technique, more workers are needed in the industry.
High wages/ salaries and high prices are motivation for workers and producers to increase the
production.

How to Address Inflation?

REASONS RESULTS POSSIBLE SOLUTIONS

1. Monopoly and
Cartel
2. Loan Payment
3. Import
Dependence
4. Excess money in
circulation
5. Export Orientation
6. High production
cost
7. Middleman