1.1 The term of inflation and its effects
In the perspective of James D. Gwartney, Richard L. Stroup, Russell S. Sobel and David MacPherson (2009 p.183), inflation is a sustained increase in general level of prices. As prices of various goods tend to raising or failing, the status of inflation describes the overall status that the impact of the rising prices would outweigh the impact of falling prices. Inflation in particular long term inflation would be influential effects over the economy practices as well as over the ordinary people’s life as the value of money declines because it directly affects the purchasing power of a currency within its borders and affects its standing on the international markets. And also inflation would not only affect the price of goods that individual consumers buy but also it would affect the prices of production material and service that enterprises buy in order to produce final goods and services.
As the issue of inflation are influential in our economy and daily life, it is important to understand the meaning of various inflation indicators that measures the degree of inflation in different perspectives.
1.2 Various inflation indicators
1.2.1 Producer Price Index
Producer Price Index measures the average price level for a fixed basket of capital, rent and materials needed for producers to manufacture consumer goods. Just as the CPI measures the prices from a consumer perspective, the PPI measures the prices at the producer level. PPI can show inflation before CPI because it will influence consumers next as they purchase these more expensive goods and services. Part of the inflation at the producer level is passed onto the consumers and therefore influences the CPI figure (cmsfx.com 2008). Producer Price Index (PPI) could act an economic indicator. The PPIs capture price movements prior to the retail level. Therefore, they may foreshadow subsequent price changes for businesses and consumers. PPI data are commonly used in escalating purchase and sales contracts. These contracts typically specify dollar amounts to be paid at some point in the future. It is often desirable to include an escalation clause that accounts for increases in input prices. For example, a long-term contract for bread may be escalated for changes in wheat prices by applying the percent change in the PPI for wheat to the contracted price for bread (bls.gov 2010).
1.2.2 Consumer Price Index
The consumer price index (CPI) is the government’s key inflation indicator and it is usually the indicator of inflation that we may think about. It is a measure of the overall cost of goods and services bought by a typical consumer. This index is based on data related to consumer spending habits and the prices paid for a variety of goods, including food, clothing, medications, energy, homes and furnishings. Usually there are five steps involved in the calculation of the consumer price index (CPI): (a) The first step in calculating the CPI is to determine which prices are most important to the typical consumers. This is also known as the fix of the basket. Surveys could be done to the particular consumer groups to identify the price goods to be researched; (b) Collect the price information regularly; (c) Calculate the basket’s cost; (d) Choose a base year and calculate the index; (e) The final step is to use the consumer price index to calculate the inflation rate which is the percentage change in the price index (Stonecash, Gans, King & Mankiw 2011, p.162).