Principles of Macroeconomics

Posted: October 17th, 2013

Principles of Macroeconomics





Principles of Macroeconomics

The consumer price index measures the overall costs of consumer goods and services purchased by a typical consumer. The consumer price index is measured as follows

Consumer Price Index = price of basket of goods and services in current year/price of basket in base year*100 (Mankiw, 2011)

A = 1.25*125/100 = 1.562

B = 1/1.34*100 = 74.63

C = 1*100/146 = 0.684

The consumer price index measures the change in living standards over a specified period. An increase in the consumer price index means that consumers will have to spend more today for the same quantity of goods. For instance, the consumer price index rose from 100 to 125 in 2007. The consumer price index is therefore used to measure the inflation in an economy. Inflation refers to the increase in the price levels in the economy. The following are the rates of inflation in 2007 and 2009

Inflation rate is calculated as follows

CPI in the second year-CPI in the first year/CPI in the second year*100

Inflation rate in 2007 was 25%, calculated as follows


The inflation rate in 2009 was 95.6%, calculated as follows


The high increase in the inflation rate seen in 2009 can be attributed to the fact that the consumer price index in 2008, decreased from the previous year. There were lower prices that year, compared to the base year. In the following year, the market prices at that time were higher than the base year prices, and this caused the consumer price index to increase.

GDP measures the total spending of goods and services in an economy. While the consumer price index measures the prices for different consumers, GDP measures the overall cost for an economy. Some of the items used to measure the consumer price index are not included when measuring the GDP. For instance, the consumer price index includes all the goods and services that the consumers purchase, regardless of whether they are imports. When calculating the GDP imports are not included, since the GDP only measures the goods and services produced in the country. Real GDP measures how the production of products changes over time, using past prices, fixed at some point. Nominal GDP on the other hand measures the cost of production using the current prices.

The nominal and real GDP of prices would differ because of the inflation rate. When calculating real GDP, the prices used are constant. When calculating nominal GDP, current prices are used, and they reflect the change of inflation. Real GDP is not affected by the changes in price, but it is affected by the quantity of output. Since nominal GDP is measured using current prices, it is affected by the output and the changing prices. Thus, measurements in real and nominal GDP would differ because of the two factors. If the inflation in the country is high, such as the case in 2009, the nominal GDP will increase significantly, but the real GDP will not reflect these changes. Real GDP is used to compare the economic growth in different countries over a specified period. High GDP is usually good for the economy, but it may also be a cause of inflation, either because of the increase in prices or because of increase in money supply (Boyes & Melvin, 2010).



Boyes, W., & Melvin, M. (2010). Macroeconomics. New York, NY: Cengage Learning

Mankiw, G. N. (2011). Principles of macroeconomics. New York, NY: Cengage Learning


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