2.2 Economic Performance and its Indicators - Price Stability

Question 1

What results in price stability?

Answer 1

Price stability results from a low and stable rate of inflation. This allows for the price to increase gradually and not fluctuate in wild and unpredictable manners.

Question 2

Define inflation, disinflation and deflation.

Answer 2

Inflation is a situation where there is a sustained increase in the general price level.

Disinflation refers to a substantial reduction in the rate of inflation. Governments aim for disinflation when inflation rates are too high as it allows prices to still keep rising but at a slower rate.

Deflation is a situation in which the prices of most goods and services are falling over time, i.e. the rate of inflation is negative.

Question 3

Define the Consumer Price Index (CPI).

Answer 3

CPI measures the price of a fixed basket of goods and services commonly purchased by a typical household

Question 4

Why is the types and specifications of the goods services in the CPI basket constant?

Answer 4

This ensures that when prices change in the subsequent years, the price of the basket and therefore the CPI changes, while the make up of the goods and services in the basket remains the same, showing that the change in CPI is due to inflation.

Question 5

What is the formula for the inflation rate?

Answer 5

Inflation rate of the current year = (CPI of the current year - CPI of the previous year) / CPI of the previous year * 100%

Question 6

What are the limitations of CPI?

Answer 6

• Substitution bias is a result of consumers switching to consuming less expensive substitutes of a good when its price increases. However, this is not accounted for as the value of each individual unit in the basket of goods and services is fixed.
• Quality adjustment bias is a issue that arises due to the goods’ prices rising when its real value increases, such as its quality.