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Price and Inflation

Price Level: Prices are of great importance in macroeconomics as indeed they are in microeconomics. However, in microeconomics we are more interested in prices of individual goods and services and such prices are rarely important for the economy as a whole although there are exceptions. In macroeconomics we are more interested in how prices change on average. We define the price level as a weighted average of several different prices.

If P1 is the price of gasoline and P2 the price of oil, then 10P1 +P2 is a price level. It is weighted average of two prices with weight 10 and 1.

Price Level and Time: We are rarely interested in the value of the price level at the particular point of time. What we are interested in is the percentage change in the price level between two points in time.

Price Index,: We are only interested in the percentage change of price level not the particular value, we can divide each price level by given constant so that the numbers are easier to deal with, when we divide a series levels by a constant, we end up with what is called a time series of price indexes.

Consumer Price Index CPI: is a price index of particular basket called the CPI basket. It contains basically all the goods and service consumed in a country, food, gas, medicine, transportation, house rent and so on.

Definition of Inflation:

The inflation between two points in time is defined as the percentage increase of the price index between these two points in time.

Price index is calculated at particular point in time. Inflation over a time period, typically over one year. Inflation is defined as percentage change in price level.

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