# General price level

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• Created on: 08-04-13 15:12

## 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.
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## General price level

• 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.
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## General price level - problems in measuring

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
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## General price level - problems in measuring

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.
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## General price level - problems in measuring

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.
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## General price level- problems in measuring

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.
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## General price level - problems in measuring

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.
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