November 6, 2010

Obviously, I spend a lot of time reading economics. One thing that has been happening with disturbing frequency of late is that after some reading and contemplation, a major insight will occur to me that is embarrassingly obvious in retrospect. My latest obvious insight is that there is nothing straightforward about calculating the rate of inflation.

Here’s the example I was thinking of:

Apples Bananas Carrots Donuts Eggs Food
2008 $4.00 $1.00 $2.00 $3.00 $2.00 ??
2009 $2.00 $3.00 $1.00 $2.00 $1.00 ??
2010 $2.00 $2.00 $1.00 $4.00 $3.00 ??

So that’s a table listing the prices of five different food items over a three-year period that I made up. The reason I made it up is to demonstrate that there is no way to figure out what should go in that sixth column, my price index for food. It’s obvious that I need to combine the possible items that I could buy into some kind of index number and measure how that changes over the years, but what weight should I give any individual item? It’s entirely arbitrary! Holy crap! What a profound and obvious insight!

Anyway the point of this post is that one of the things your economics teacher didn’t tell you is that “the” rate of inflation is entirely arbitrary. How would you solve this problem?


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