On January 26, 2010, the film Avatar officially topped Titanic as the top-grossing film of all-time at the box office. However, the following day, Forbes.com published an article entitled Is Avatar Really King of the Box Office? The article explains how using calculations such as the Consumer Price Index (CPI), one can show how the film Gone With the Wind has grossed more when the value of the box office receipts are adjusted for inflation.
In this lesson you will examine the causes behind and the consequences of inflation. You will also learn to use the Consumer Price Index and the GDP Deflator in order to calculate changes in the general price level from year to year and over time.
Start by watching a short trailer
to the film Avatar. Most of us are familiar with the film Avatar, early in 2010 it became the highest grossing film of all time. However according to an article from Forbes entitled, Is Avatar Really King of the Box Office?
There exists a discrepancy between the value of the dollar between one year and another. The change in the purchasing power of a dollar results from inflation or deflation, but what is inflation? How do economists calculate changes in the value of dollar domininated goods and services?
Avatar’s total box office receipts according to BoxOfficeMojo is $760,507,625 domestically. However, when this figure is adjusted for inflation by adjusting the 2011 ticket price to the 1939 ticket price, the year which Gone With the Wind was released, Avatar drops to number 14 on the list with an adjusted gross of $22,368,700. Gone With the Wind was released multiple times over the years and has totaled almost $200 million (unadjusted) in total domestic box office. When the total for Gone With the Wind is adjusted for inflation into current dollars, the total gross is $1,618,377,500. The average cost of a ticket to see Gone With the Wind in 1939, was just $0.23. Today, the average ticket cost $7.86 (May, 2011). BoxOfficeMojo estimates that the number of tickets sold for Gone With the Wind was over 200 million and that Avatar sold just under 100 million. When the data is adjusted so that output (tickets sold) is basis for their list of the top movies of all time, Gone With the Wind is easily number one.
So why is there such a difference in the prices for goods and services in the 1930s as opposed to the prices which we see today? The short answer to this question is inflation. Inflation is defined today as a sustained rise in the general price level of all the goods and services produced in an economy. The rise in prices can be attributed usually to an increase in the amount of money and credit relative to the available goods and services. There are other causes of inflation, however these causes are attributed to changes in supply and demand for goods and services. Cost-push inflation is inflation causes by rising costs of production. Demand-pull inflation is inflation caused by increasing demand for output or “too much money chasing too few goods.”
To better grasp the general idea of inflation, watch a quick 1-minute video from investopedia.com . Given that inflation exists and has been persistent over the past century, how do we measure the rate of inflation? When new money and credit is created and circulates in the economy it does not affect the prices of all goods and services equally over the short run and even to some extent over the long run. Imagine if the amount of money is doubled, that does not necessarily mean that everything will cost twice as much. This is known as the non-neutrality of money, which makes it necessary for us to have some measure of how the prices are changing as new money and credit enters in the economy. The most common measure of price inflation used today is known as the consumer price index or CPI. The consumer price index is a measure, which is used to calculate the changes in the price level of everyday goods and services that are purchased by households. The CPI consists of a basket of market goods and services, the prices of which are weighted and averaged and then compared against different time periods. For further explanation, please visit the Minneapolis Federal Reserve website .
A second commonly used measure of the rate of inflation is the GDP Deflator. The deflator is based of a Gross Domestic Product or GDP, which is the market value of all final goods and services produced in a country in a calendar year. GDP attempts to represent the total amount of output of a country in a given year by tabulating the value of all new goods and services which have been produced that year (goods which are re-sold or used goods are not a part of GDP). Nominal GDP is a multiplication of the all the goods and services sold that year multiplied by the prices in which they are sold. But because prices fluctuate over time, in order to calculate the actual growth in output known as real GDP, it becomes necessary to adjust the nominal figure into real terms. Real GDP is calculated by multiplying the quantity of goods sold by a constant price level, usually a given base year. The GDP deflator is used then to calculate the rate of inflation between one year and another. Learn how to calculate Nominal GDP, Real GDP and the GDP Deflator here. For more information, please visit the website of the Dallas Federal Reserve Bank .
The website Box Office Mojo uses a different method than to calculate their adjusted box office gross. Instead of being concerned with a basket of goods or a measure of the overall price level, they look specifically at the average ticket price and adjust their box office gross figures according to an estimated amount of tickets sold. Because there is no way to perfectly calculate the effects of inflation on the price level, even adjustments made by CPI and the GDP deflator are imperfect as there are at all times a number of different factors that could lead to a discrepancy in prices.
One should always be alert to the reasoning behind changes in prices for different goods and services. Under a system of flexible prices, the price of any product is always changing based on changes in supply and demand (think of day-to-day changes in the prices of stocks and commodities). Money is a medium exchange used in a market economy operating under a price system. Changes in prices communicate information to buyers and sellers about the relative scarcity or abundance of goods. Low prices are a sign of relative abundance and high prices signal relative scarcity, each tells consumers and producers how they should model their behavior as they go about employing resources to meet their desired ends. Just as the value of goods and services respond to changes in supply and demand, money is also subject to similar changes. The underlying cause of a sustained increase in the prices for all goods and services in the economy is often an indicator of excessive money creation. Inflation measures such as CPI and the GDP Deflator are helpful in gathering information in order to give one a general idea of price level from one year to the next. However, any measure of inflation is imperfect in one way or another.
Ignorance of inflation can lead to distorted interpretations of data, which can lead to misinformation about the true nature of economic indicators. People who see substantial rises in incomes, home prices, fuel prices etc. should always be aware of whether or not these changes reflect adjusted or unadjusted data. One might think that the prices of consumer goods are rising rapidly, but if incomes are rising faster then the real value of consumer goods has fallen and become relatively more abundant, meaning that we are wealthier.
Complete the following two worksheets.
Process Questions for Avatar Lesson (All data is based on statistics taken on March 15, 2011, data is subject to change.)
2. Test your knowledge of GDP calculation by completing the following worksheet. The worksheet creates a four good economy of a movie theater and asks you to calculate a nominal and real GDP, and a GDP deflator for the movie theater.