ECONOMICS

SESSION: 10
PROF.DR. KUNAL SAIGAL

TITEL DER PRÄSENTATION | TITEL VORNAME NAME 06.01.2025 1

 Definition of Inflation and Deflation
◦ Inflation: Increasing general price levels over time
◦ Deflation: Decreasing general price levels
Effects of Inflation
◦ Decreased purchasing power of money
◦ Rising prices and product shortages
◦ Falling exchange rates (ppl purchase foreign currency)

Definition of ◦ Increased demand for consumer goods and services

Low and Stable Inflation
Inflation and ◦ Annual inflation around 2% is considered low and stable and
known as “creeping inflation”
Deflation High Inflation is when inflation is above 5% per year
Hyperinflation - Hyperinflation occurs when the monthly
increase in prices is over 50 percent, and the annual inflation
rate can be in the thousands.
Money suddenly loses all its value and does not perform its
functions. Constant price increases undermine normal economic
relations and disrupt financial and credit mechanisms. As a
result, an economy can turn to barter relations.
Measuring Inflation and the Consumer Price Index
Definition and Importance of Price Indices
◦ Price indices measure changes in the general level of prices
◦ GDP deflator vs. Consumer Price Index (CPI)
◦ GGP deflator measures change sin prices of all products over time
◦ CPI measures changes in prices of specific products & services which
consumers buy

Consumer Price Index (CPI)

◦ Focuses on changes in prices for goods and services consumers buy
◦ Official rates of inflation are based on the CPI

Calculation of CPI
◦ Based on the consumer basket of goods and services
◦ Involves selection of goods, data collection, and calculation

◦ The consumer price index is based on the concept of the consumer basket of
goods and services. The consumer basket includes goods and services that
households of a country buy for the purpose of consumption.
◦ In Germany, the consumer basket includes over 650 individual product types.
◦ Different goods have different weightage and this effect on the calculation of
the CPI.
◦ In Germany, the weighting pattern was revised in 2015 and the share of
housing in the consumer basket increased from 31.7 percent to 32.5 percent,
the share of health increased from 4.4 percent to 4.6 percent, while the share
of food and non-alcoholic beverages dropped from 10.3 percent to 9.7 per- cent
Measuring Inflation and
the Consumer Price Index
The calculation of the CPI is a multistage process
that involves:

(1) a selection of goods and services for the

consumer basket and determination of their
weighting pattern,

(2) data collection on prices in the consumer

basket, and finally

(3) calculation of the CPI.

The CPI is calculated by comparing the cost of

the consumer basket in the current prices to the
base year prices:
Measuring Inflation and the Consumer Price Index
The following simplified example shows how the CPI can
be calculated. Suppose a consumer basket includes only
three types of products:
1. Apples
2. Tomatoes
3. Fish
STEP 1
The table below shows the quantities in the basket and The first step is to calculate the cost of the
the change in prices per unit of the product. consumer basket.

The cost of the CPI basket in the base year 2019

Measuring Inflation and the Consumer Price Index
The following simplified example shows how the CPI can
be calculated. Suppose a consumer basket includes only
three types of products:
1. Apples
2. Tomatoes
3. Fish
STEP 2
The table below shows the quantities in the basket and The second step is to calculate the cost of the
the change in prices per unit of the product. consumer basket.

The cost of the CPI basket in the base year 2020

Measuring Inflation and the Consumer Price Index
The following simplified example shows how the CPI can
be calculated. Suppose a consumer basket includes only
three types of products:
1. Apples
2. Tomatoes
3. Fish
STEP 3
The table below shows the quantities in the basket and The third step is to calculate the cost of the
the change in prices per unit of the product. consumer basket.

The cost of the CPI basket in the base year 2021

Measuring Inflation and the Consumer Price Index
The following simplified example shows how the CPI can
be calculated. Suppose a consumer basket includes only
three types of products:
1. Apples
2. Tomatoes
3. Fish
STEP 4
The table below shows the quantities in the basket and The fourth step is to calculate the CPI for 2020 &
the change in prices per unit of the product. 2021 using the following formula.

The CPI IN THE BASE YEAR is 100

Measuring Inflation and the Consumer Price Index
The following simplified example shows how the CPI can
be calculated. Suppose a consumer basket includes only
three types of products:
1. Apples
2. Tomatoes
3. Fish
STEP 5
The table below shows the quantities in the basket and The fifth step is to calculate the CPI for 2020 &
the change in prices per unit of the product. 2021 using the following formula.

The CPI IN THE BASE YEAR is 100

Measuring Inflation and the Consumer Price Index
The following simplified example shows how the CPI can
be calculated. Suppose a consumer basket includes only
three types of products:
1. Apples
2. Tomatoes
3. Fish
STEP 6
The table below shows the quantities in the basket and The sixth step is to calculate the inflation rate for
the change in prices per unit of the product. 2020 & 2021 using the following formula.
Measuring Inflation and the Consumer Price Index
The following simplified example shows how the CPI can
be calculated. Suppose a consumer basket includes only
three types of products:
1. Apples
2. Tomatoes
3. Fish
STEP 3
The table below shows the quantities in the basket and The third step is to calculate the inflation rate
the change in prices per unit of the product. for 2020 & 2021 using the following formula.
 It is widely acknowledged that the CPI does not perfectly
reveal the level or effects of inflation because of the
following biases:
1. New product bias
2. Change in the quality of products
3. Product substitution bias
Limitation of 4. Outlet substitution bias

Inflation
Statistics
 Depending on the reasons and mechanism of growth in the overall
price level, economists distinguish between two main groups of
factors and inflation types: demand-pull inflation and cost-push
inflation
Demand-Pull Inflation
◦ Occurs when expenditure grows faster than supply
◦ Can be triggered by a single event like increased government spending
◦ Common in booming economies
Causes of ◦ Factors include net export increase, excessive government spending,
and inflation expectations

Inflation ◦ AD curve shifts to the right

When demand continuously grows and the economy is close to its

potential level of output, the manufacturing sector cannot respond
with an increase in the real volume of production because all the
available productive resources are already employed.
This causes persistent excess demand and drives the prices up. This
process can be shown with the AD–AS model as a shift of the AD
curve to the right.
 Depending on the reasons and mechanism of growth in the overall price
level, economists distinguish between two main groups of factors and
inflation types: demand-pull inflation and cost-push inflation
Cost-Push Inflation
◦ Associated with rising costs and leftward shift of the supply curve
◦ Caused by wage rate growth, increased interest rates, and rising resource
prices
◦ Can occur during high unemployment and incomplete resource use

Causes of ◦ Leads to price increases and reduced production volumes

In contrast, cost inflation is associated with the leftward shift of the

Inflation supply curve and occurs as a result of rising costs.
Rising costs can be associated with the growth of wage rates, an increase
in interest rates, rising prices for resources (in particular for energy), and
disruptions in the global value chains.
In addition, rising production costs can occur dur- ing periods with high
levels of unemployment and incomplete use of production resour- ces.
Prices increases as a result of rising production costs per unit of
production.
At the same time, resource prices are growing at a higher rate compared
to growth in labor productivity. Cost-push inflation creates stagnation
when prices rise and production volumes are reduced simultaneously.
 Redistribution of Incomes
◦ Prices and wages do not increase proportionally
◦ Purchasing power of nominal incomes erodes
◦ Real incomes fall for those with fixed incomes
Redistribution of Wealth
Consequences ◦ Fixed-rate loans cause a fall in real interest rates
◦ Borrowers benefit, lenders are harmed
of Inflation ◦ Value of savings decreases
◦ Lower incentives to invest in long-term projects
Negative Effects on Real GDP and Employment
◦ Uncertainty and demotivation for firms to invest
Positive Effects of Moderate Inflation
 Gross Domestic Product (GDP)
◦ Main indicator for assessing national economy
◦ Used for international comparisons and other
macroeconomic indicators
◦ Calculated as the sum of household expenditure, private
investments, government expenditure, and net export
Nominal vs Real GDP
◦ Nominal GDP: Calculated in current prices
Summary ◦ Real GDP: Uses base year prices
◦ Real GDP is used to measure economic growth over
time
Circular Flow Model
AD-AS Model
Labor Market Indicators
Inflation