Problems with measuring inflation

Syllabus: Explain that inflation figures may not accurately reflect changes in consumption patterns and the quality of the products purchased.

$S:\triplea_resources\DP_topic_packs\economics\student_topic_packs\media_macroeconomics\images\3dperson_question.jpg$ There are several problems when trying to measure inflation. These include:

Changes in the quality of the goods and services included in the index. As R and D and technology imporvements feed into the design and production of many goods, so their inherent quality increases, but this is not always reflected in price levels. So comparing goods over time is problematic - try comparing personal computers from 10 years ago with now.
Special offers, which are now a feature of 'high street shopping' do not feature in the index and so people may be buying some products for a significantly lower price than the index is showing.
We also change our expenditure (Consumption) patterns. Although the weighting patterns are reviewed annually modern marketing can result in quick changes in consumer tastes.
The index is based on a sample and these can always be less accurate than was hoped. This introduces sampling errors into the figures.
Weighting is based on 'average' spending patterns. Thus the more a person deviates from the average, the less meaningful will be the official inflation rate for them. For example, food and heating and lighting costs may account for a much larger proportion of the income of low income groups than high income groups, so any price inflation of these items will disproportionately affect the poor. For example, a published rate of inflation of 3% may mean an effective rate of inflation of 10% for the less well off.

Syllabus: Explain that economists measure a core/underlying rate of inflation to eliminate the effect of sudden swings in the prices of food and oil, for example.

Some goods have notoriously unstable prices (just look at what has happened to the price of oil - record highs and record lows at the moment), agricultural prices are also very unstable due to weather changes. Therefore, when comparing prices over time a core or underlying inflation rate is calculated which removes these flucuations - you do not need to know how this is calculated etc.

Syllabus: Explain that a producer price index measuring changes in the prices of factors of production may be useful in predicting future inflation.

Producer Price Index

A typical supply chain consists of producers selling in bulk to wholesalers who put a profit mark-up on goods and then resell to retailers in smaller amounts but higher mark-up price and retailers then sell to consumers with a further mark-up price and usually in single items.

One way to foretell future consumer price inflation is by looking at the change in prices charged by producers (Often this is referred to as - Factory Gate prices). If these increase then it is a sign that consumer prices will also increase in the near future. To calculate what is happening to producer prices a Producer Price Index (PPI) is calculated.

Past Paper Essay Questions

Nov 2013

4. (a) Explain why measuring the rate of inflation using a consumer price index (CPI) may not be accurate. [10 marks]

(b) Evaluate two government policies to reduce inflation. [15 marks]

Nov 2009

2. (a) Explain how the rate of inflation might be measured and the factors which might make accurate measurement difficult. [10 marks]

(b) Evaluate the extent to which an individual government can influence the rate of inflation in its economy.
[15 marks]

Macroeconomics

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Problems with measuring inflation