Inflation and price stability
Key terms
Define each term.
Multiple choice
Circle the correct answer.
A country's currency depreciates sharply, raising the price of imported oil and components. This is most likely to cause:
Worked problems
Show your working.
Building a weighted price index. A country's basket has four categories. Their weights and this year's price indices (base year = 100) are: Food: weight 40, price index 110. Housing: weight 30, price index 105. Transport: weight 20, price index 120. Other: weight 10, price index 100. Calculate the weighted price index and state what it shows.
Answers
Inflation: A sustained increase in the general price level of an economy over a period of time.
Deflation: A sustained fall in the general price level of an economy over a period of time.
B. Higher import costs raise firms' costs of production, which are passed on as higher prices. That is cost-push inflation.
Step 1. Multiply each price index by its weight. Food 40 x 110 = 4,400. Housing 30 x 105 = 3,150. Transport 20 x 120 = 2,400. Other 10 x 100 = 1,000.
Step 2. Add them and divide by the total weight. Total = 4,400 + 3,150 + 2,400 + 1,000 = 10,950. Total weight = 100. Weighted index = 10,950 / 100 = 109.5.
Step 3. Interpret. Prices on average are 9.5% higher than in the base year. Transport rose most, by 20%, but it has a weight of only 20, so it adds less to the index than food, which rose 10% with a weight of 40.
The weights are the point. A simple average of the four indices would give 108.75, which ignores how much people actually spend on each category.