INTRODUCTION TO

MACROECONOMICS
TOPIC 2: MEASUREMENT OF THE COST
OF LIVING (INFLATION)
 Price Comparisons, 2002 and 2023:
Selected Goods in Vietnam
Items (unit: VND) 2002 2023
1kg of rice 4k 20k
1kg of pork 30k 60k
23k
1 liter of petroleum 4k
4.8k
1kg of retail steel 15k
6k 50k
A bowl of phở at big city
A motorbike (popular line) 20 mil 45 mil
3-4k 1k
One minute of prepaid mobile phone call
Monthly minimum wages 0.29 mil 3 – 4 mil
Per capita GDP $438 $4,284
Data sources: compiled from public sources and used only for the teaching purpose. Note: motor bikes are Dream 2 and Air Blade. For pork, rice, petroleum and steel, the prices
are collected from average-quality products.
Price Comparisons, 1970 and 2017:
Selected Goods in the US

Source: Principles of Economics, Economics and the Economy, 2e by Timothy Taylor

4
Motivating Questions
• If you wake up overnight and see prices of everything increase by
30%, what do you feel?
• People have different baskets of consumptions and perceptions of
price changes.
• The poor vs the wealthy.
• The rural vs the urban.

• There are countless of goods and services in the market, how to

track prices of them into a single aggregate number?
Inflation
• Inflation is a general increase in prices.
• It is translated as “lạm phát” in Vietnamese – literally as: “phát quá
mức”

• The opposite of inflation is deflation – a general fall in prices.

• It is translated as “giảm phát”.
Price index
• How to track changes of the general (overall) prices of the
economy?
• Use an aggregate index.
• Measure the index’s percentage (%) change over a year.

• How to aggregate (pool) prices of hundred thousands of goods

and services into a single measurement.
How is CPI calculated?
• Pick a basket of goods and services. Here we choose the basket
of a typical consumer of the economy.
• Choose the base year and compute the index for this basket.
• Designate one year as the base year, making it the benchmark
against which other years are compared.

8
 CPI calculation (1)
Fixed basket of 4 durians and 2 milk tea
Year price of durians price of milk tea
2022 $10 $20
2023 $12 $24
2024 $13 $26
YEAR COST of BASKET
2022
2023
2024
YEAR CPI index (2023 is the base year = 100)
2022
2023
2024
9
 CPI calculation (2)
Fixed basket of 4 durians and 2 milk tea
Year price of durians price of milk tea
2022 $10 $20
2023 $12 $24
2024 $13 $26
YEAR COST of BASKET
2022 $10 * 4 + $20 * 2 = $80
2023 $12 * 4 + $24 * 2 = $96
2024 $13 * 4 + $26 * 2 = $102
YEAR CPI index (2023 is the base year = 100)
2022 100
2023 96/80*100 = 120
2024 102/80*100 = 127.5
10
Inflation rate using CPI (1)
• The inflation rate at time t is the percentage change in the price
level from time t-1
• The inflation rate is calculated as follow:

11
Inflation rate using CPI (2)
Inflation rate
CPI (2022: Base year)
(compared to the previous year)

2022 100 n.a.

2023 120

2024 127.5

12
Basket as weights of goods and services
Fixed basket of 4 durians and 2 milk tea

Durian’s weight =
Milk tea’s weight =
CPI at year = relative + relative
CPI at 2023 =

Weight of products
• Durian: 33%
• Milk tea: 67%

13
Vietnam’s CPI Breakdown: Median Family’s
Expenditure
2009-2014 2015-2020 2021-2025
Foods 39.9% 36.1% 33.6%
Cereals and cereals' products 8.2% 4.5% 3.7%
Non-cereals foods 24.4% 22.6% 21.3%
Foods away from home 7.0% 9.1% 8.6%
Beverages and Cigarettes 4.0% 3.6% 2.7%
Clothes and Shoes 7.3% 6.4% 5.7%
Housing and Construction Materials 10.0% 15.7% 18.8%
House’s Appliances 8.7% 7.3% 6.7%
Healthcare 5.6% 5.0% 5.4%
Transportation 8.9% 9.4% 9.7%
Communication 2.7% 2.9% 3.1%
Education 5.7% 6.0% 6.2%
Entertainment and Culture 3.8% 4.3% 4.6%
Other services 3.3% 3.3% 3.5%
14
Vietnam’s CPI Breakdown
Vietnam’s CPI Bracket: an example
Components Weight * 2023
Components Weight Sum up
values in 2023 values
Foods 33.6% 101 33.9
Beverages and Cigarettes 2.7% 104 2.8
Clothes and Shoes 5.7% 103 5.9
Houses and Construction Materials 18.8% 102 19.2
Households Appliances 6.7% 105 7.0
Healthcare 5.4% 103 5.6 102.7
Transportation 9.7% 105 10.2
Communication 3.1% 107 3.3
Education 6.2% 102 6.3
Entertainment 4.6% 104 4.8
Other services 3.6% 102 3.7

With 2022 as the base year (index value = 100). The inflation rate of 2023 = 102.7/100 - 1 = 2.7%
Implications of inflation
• In term of purchasing power, the same amount of money today is
different from many years ago:
• Example: can you have the same living standing with the same salary of 10 mil
VND in 2013 and 2023?

• Real versus nominal amount:

• The nominal VND is the amount of money which is not adjusted for inflation.
• The real VND is the nominal number which is adjusted for inflation.
• Example: with the inflation rate at 2.07%, 10 mil VND in 2022 is equivalent to
VND in 2023
Check

If the CPI was 90 in 2000 and is 225 today, then 100k VND today
purchases the same amount of goods and services as
A. 25.00k VND purchased in 2000.
B. 33.33k VND purchased in 2000.
C. 40.00k VND purchased in 2000.
D. 135.55k VND purchased in 2000.
Check

If all items in the economy increase by less than 5%, what is the
possible inflation rate?
A. More than 5%
B. Less than 5%.
C. Exact at 5%
D. Cannot be determined.
Why CPI may overstate inflation?
• Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers’
ability to substitute toward goods whose relative prices have fallen.
• Introduction of new goods: the introduction of new goods makes consumers
better off and, in effect, increases the real value of the money. But it does not
reduce the CPI, because the CPI uses fixed weights.
• Unmeasured changes in quality: quality improvements increase the value of
the money, but are often not fully measured.

20
Price Indices (1)
• Consumer price index (CPI)
• Percentage change in the price index using consumer’s spending
basket.
• Measure how a ‘typical’ consumer experience prices’ change.
• Core CPI
• Measure of the overall cost of consumer goods and services excluding
food and energy.
• To exclude the volatility of food and energy’s prices.
Price Indices (2)
• Producer price index, PPI
• Measure of the cost of a basket of goods and services bought by firms –
the inputs of production of the economy.
• Changes in PPI are often thought to be useful in predicting changes in
CPI.
• GDP deflator
• Look at the prices of final goods produced in the economy.
• Include investment (capital) goods purchased by firms.
• Exclude imported goods.
GDP deflator
• GDP deflator
• A measure of the overall level of prices.

• Measures the current level of prices relative to the level of prices in the
base year

• The economy’s inflation rate

• Compute the percentage increase in the GDP deflator from one year to
the next.
23
CPI vs GDP deflator
• Prices of capital goods:
• included in GDP deflator (if produced domestically).
• excluded from CPI.

• Prices of imported consumer goods

• included in CPI.
• excluded from GDP deflator.

• The basket of goods

• CPI: fixed for the period of observation.
• GDP deflator: changes every year.
24
Vietnam inflation rate (CPI)
25.0

20.0

15.0

10.0

5.0

0.0
19961997199819992000200120022003200420052006200720082009201020112012201320142015201620172018

-5.0

Data source: General Statistics Office of Vietnam 25

Vietnam inflation rate (CPI and GDP
Deflator)
45.0

40.0

35.0

30.0

25.0

20.0

15.0

10.0

5.0

0.0
19961997199819992000200120022003200420052006200720082009201020112012201320142015201620172018
-5.0

Data source: General Statistics Office of Vietnam 26

Contribution to Vietnam's cumulative month-by-month CPI
changes by components
4

3.5

2.5

1.5

0.5

-0.5
Foods Houses and Construction Materials Drinks and Cigarettes Clothes and Shoes Households Applicances Healthcare
-1
01/2006
Education 07/2006
Entertainment 01/2007 07/2007
Miscellaneous01/2008 07/2008
Transportation 01/2009 07/2009

Data source: General Statistics Office of Vietnam 27

American CPI’s backet
US Inflation decomposition
on December 2022
US Inflation decomposition
on December 2023
Inflation rate around the world

https://www.imf.org/external/datamapper/PCPIPCH@WEO/OE
MDC/ADVEC/WEOWORLD
Check
If the price of clothes imported into the Vietnam increases, then
A. Both the GDP deflator and the CPI will increase.
B. Neither the GDP deflator nor the CPI will increase.
C. The GDP deflator will increase, but the CPI will not increase.
D. The CPI will increase, but the GDP deflator will not increase.
Inflation is good or bad?

The context: Argentina is a midsize country with more than 40

mil of population, (nominal) GDP per cap is $13,700 (2023). The
country has a long history of various economic problems:
bankruptcy on the national debt, inflation…

https://www.youtube.com/watch?v=sWr-Ht1S_4U
Reflection questions
• How Argentinian people react to high inflation rates?

• If you, as a consumer or a business owner, were in the same

position, would you behave in the same way?

• Do people have a high trust on the national currency (the peso)?

Interpreting inflation rates (1)
• For normal individuals, if nominal wages do not keep up with
price changes, the real income of people suffers.
• Example: the annual inflation rate is 10%, but the wage only increases
by 5%. Roughly, this person loses 5% of his/her income.

• For the lenders, if the agreed interest rate cannot match up with
the pace of inflation, the lenders get loss on their loans.
• We will cover more adverse effects of high inflation on the
whole economy on later lectures.
Interpreting inflation rates (2)

The question:
The price of phở Bát Đàn increases twice from 20k in 2010 to
40k in 2018. However, from the official CPI index, the index
of 2010 is 100 and goes up 159.11 in 2018. Does the
government underestimate the true scalce of price increase?
Everyone‘s “real” inflation rate?
• Each consumer has his/her own consumption’s basket.
• Low-income people spend more money on foods and houses.
• Increases in prices of foods impacts people’s experience more than
others’ goods and services.
• Regional differences matter.

• The same logic applies for small producers and firms.

• Inflation measurements are just useful to track the prices of the
economy.
Check
Under which of the following conditions would you prefer to be the lender?
A. The nominal rate of interest is 15 percent and the inflation rate is 14
percent.
B. The nominal rate of interest is 20 percent and the inflation rate is 25
percent.
C. The nominal rate of interest is 12 percent and the inflation rate is 9
percent.
D. The nominal rate of interest is 5 percent and the inflation rate is 1
percent.
Stable price level
• In general, some economists advocate for the stable price level
with the inflation rate being at 2-3%.
• Others can accept for overall 4-5% rates.
• However, when the inflation rate shoot up to over 7-8%, the
economy may be under troubles. Under these cases, the
government is advised to step in to lower the inflation rate.
Deflation
• It happens when the general prices of the economy decline.
• Typically, when the economy is under deflation or very low
inflation (~ 0%):
• The demand of the economy is low. The sellers may need to lower their
prices to compete for consumers. It means the total production of the
economy may decrease to meet up with lower demands.
• People are expecting a struggling economy: little economic growth or
economic recession.
China’s recent deflation
 Hyperinflation
• Hyperinflation is the case that a country experience an
extremely high inflation rate.
• Example: Zimbabwe recorded 2,200,000% inflation rate
in 2007 with the highest monthly inflation at
79,600,000,000% (prices doubled every 24.7 hours)
• Germany after World War 2. Highest monthly inflation
at 29,500% or prices doubled every: 3.7 days.
• Vietnam’s “mild” hyperinflation period during 1985 –
1990.

42
Vietnam hyperinflation during the late
1980s
Inflation rate as GDP Deflator
450% 411%
398%
400% 363%
350%
300%
250%
200%
150%
100% 70% 73%
50% 42% 33%
0%
1986 1987 1988 1989 1990 1991 1992

Data source: World Bank

43
Hyperinflation in Venezuela

https://www.youtube.com/watch?v=fnLM2fXeXY4
The causes of inflation: preliminary
discussions
• Demand-pull inflation:
• Too much purchasing power chases too little goods.

• Cost-push inflation:
• Supply shocks: world oil price or food prices, supply chain bottleneck.
• Natural disasters: disruptions in the domestic supply chain or supply
of goods.

• A complete lecture will be delivered on Topic 7.

Summary
• Inflation is the general increases in prices.
• A variety of indices is used to capture inflation: CPI, PPI, core
CPI, GDP deflation.
• High rates of inflation is considered not to be good for the
economy; but a little inflation is preferred to deflation.