Price indices, inflation and its costs

Learning objectives

Construct a price index from a fixed market basket, calculate the consumer price index (CPI) and use it to measure the inflation rate between two years

Explain how the CPI can misstate changes in the cost of living because of substitution, quality change and new products, and compare it with the GDP deflator

Distinguish inflation, disinflation and deflation, and convert nominal values to real values using a price index

Explain the costs of inflation, including menu costs, shoe-leather costs, unit-of-account costs and the loss of purchasing power

Show how unanticipated inflation redistributes wealth between borrowers and lenders and between workers and employers, and why fully anticipated inflation is less harmful