General price level

HOW IS THE VALUE OF MONEY MEASURED?

• The value of money is its purchasing power, that is, the amount of goods and services that can bepurchased with a given amount of money. 

• The value of money depends on the general price level.

• In other words, changes in the price level cause changes in the purchasing power of money. 

• When the general price level rises, the value of money falls because the given amount of money will buy less goods and services.

• In practice, changes in the price level and in the value of money are measured by a price index.
• This is a statistical measure that expresses the average price of some group of commodities in some year as a percentage of the average price of the same commodities in some other year.

RPI calculation involves 3 main stages 

• 1. A survey to find out what families buy and how much they specd on particular items - this provids the weights 

• 2.Recording how much the prices of some 600 selected items have changed - this information is collected from all main typesof retail outlets, as well as from Gas , water, electricity and transport suppliers at a base date. 

• 3. The percentage change in price for each item is then multipiled by its weight- from this the average change in the RPI is determined. 

PROBLEMS IN MEASURING CHANGES IN THE VALUE OF MONEY:

• 1. The choice of the base year

• 2. Finding a representative group of commodities

• 3. Computing the weights

• 4. The price index is not able to take into account changes in quality

1. The choice of the base year:

• The selection of the base year is a very complicated task.

• The prices in the chosen base year should be reasonably steady. Periods of severe inflation, deflation or recession should be avoided.

2. Finding a representative group of commodities: 

• In selecting commodities to include in the basket of goods, accurate information on expenditurepatterns of households is needed.

• But there are great difficulties in collecting such data.

•  People are unwilling to disclose their expenditure truthfully.

• Besides, different income groups do not share the same basket of goods.

• Even people with the same income do not buy the same commodities in the basket.

• Thus, the construction of consumer price index involves a lot of guesswork.

3. Computing the weights:

• The assignment of weights also involves a certain amount of guesswork.

• The weights in the index are devised to take account of the relative importance of different goods in the pattern of expenditure.

• But there is great difficulty in obtaining information because people are usually reluctant to reveal how they spend their income.

• Furthermore, this weight will not necessarily be typical of what each household consumes.

• Each household consume bundles of goods and services that differ from one another.

4. The price index is not able to take into account changes in quality:

• A commodity may not have changed in price but its quality may have fallen. 

• Conversely, a good may be more expensive because it is of a better quality than before. Such changes in quality affect the consumer’s standard of living but cannot be reflected in the price index.