Principles of Macroeconomics / Unit 6 MAC 0506 worked example, 60 to 90 seconds
Computing the Inflation Rate
The idea
The inflation rate between two periods is the change in the index divided by the earlier index, times one hundred. Subtract the earlier index from the later one, divide that difference by the earlier index, and multiply by a hundred. The divisor is always the earlier value, never the later one and never a hundred. Doing it the other way gives a different answer, and the difference grows as the index moves further from a hundred.
In practice
Worked example: the index goes from one hundred and seven to one hundred and ten. The change is three. Three divided by one hundred and seven is about two point eight percent. Subtracting the two index numbers to get three percent is close here and wrong, and at an index of two hundred the same shortcut would be wrong by half.
Where people slip
This is the misconception the exam tests most often here. An index is not a percentage, so the gap between two index numbers is not an inflation rate, and it only looks like one while the index is near a hundred.
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