Consumer Price IndexCPI

Week 7LSP 120Joanna Deszcz

PricesName some prices that have

changed in your lifetime◦Prices that have increased◦Prices that have decreased

An Example◦Guess the Price

Percentage Increase 1962-1998

Item Percentage Increase in Price

Hershey bar 1180%New York Times 1100%First class postage 700%Gasoline (gallon) 284%Hamburger (McDonald's double) 861%Chevrolet (full size) 790%Refrigerator freezer 60%

How does the quality of each item compare from 1962 to 1998?

What have we learned so far?Prices can and do change

dramatically in relatively short periods◦Price from the past can become

virtually meaninglessPrices of items do not go up

consistently◦Some go up faster than others

Items change over time ◦Becomes difficult to compare prices

because the items are not really comparable

InflationThe general increase of the price

of goods over timeNo obvious quality improvementOkay as long a our income

increases at same rate or higherIf not, not as well off as we thinkAlso important to financial

planning◦$100 today will not buy as much in

20 years

Inflations Effect on $1.00

Some questionsHow do we compare prices of

today with those of the past?How do we measure inflation?

Consumer Price IndexWay to compare prices in

different yearsEconomists choose a “bundle” or

“basket” of goods in varying proportions

Components of the CPI(U) Housing 41.4%Transportation 17.8%Food 16.2%Energy 8.2%Medical Care 6.4%Apparel and Upkeep 6.1%Other 3.9%

CPI ContinuedThe cost of the bundle is

assigned an index numberThe following year the cost of the

same bundle is determinedCPI for that year = new cost of

bundle

Official CPI 1990-2008Year

CPI1982-84=100

1990 130.71991 136.21992 140.31993 144.51994 148.21995 152.41996 156.91997 160.51998 163.01999 166.62000 172.22001 177.12002 179.92003 184.02004 188.92005 195.32006 201.62007 207.32008 215.3

How to read the table◦ Used to compare

prices of any two years

◦ Example: same goods that cost $130.70 in 1990 would cost $172.20 in 2000

◦ So $130.70 in 1990 = $172.20 in 2000

Initial Index value = 100 and represents average CPI of 1982-84

Relationship Between FactorsCan calculate how many times

more the prices of goods were in one year than in a

Calculate the ratio of the CPI values

So, goods in 2000 cost 1.302 times more than in 1990 (on average)

2000 CPI = 170.2 = 1.302 1990 CPI 130.7

Converting to Constant DollarsComparing amounts from 2 different

yearsCan convert any money related variables

◦Prices, wages, salariesCurrent prices for each year are called

nominalCompare prices taking changing value of

money into accountConvert one price to same year as other

◦Usually convert forward to more recent year

ExampleThe price of gasoline in 1990 was

$1.16 per gallon on average. In 1997, it averaged $1.23. Was gasoline more expensive or less expensive in 1997? ◦1990 $130.70 equivalent to $160.50 in

1997◦1997 CPI = 160.5 = 1.23

1990 CPI 130.7 So $1.00 in 1990 = $1.23 in 1997

◦Multiply 1990 value by 1.23 (1.16 * 1.23) So $1.16 in 1990 = $1.42 in 1997

Another ExampleYour instructor said she made

$22,000 a year at her first job out of college in 1993.  That doesn't sound like a lot of money to us today, but we must consider that everything was less expensive in 1993. 

What is that salary worth in today's money (in 2008)? 

Compare Prices in Consecutive Years

Convert entire series of prices to constant dollars

Use Excel

Electricity Prices1986 - 1997

Electricity Prices (US city average, per KWH)

 

Year Price 

1986 $0.077

1987 $0.079

1988 $0.080

1989 $0.082

1990 $0.084

1991 $0.087

1992 $0.088

1993 $0.092

1994 $0.092

1995 $0.094

1996 $0.094

1997 $0.094

As a Graph…

Is this a realistic depiction of the price of electricity?

Huh?Did price of electricity increase

really?Value of dollar deceased each

yearNominal cost increasedWhat about constant dollars?Convert 1986 values to 1997

dollars tp find out

Here’s how…Year Price  CPI1986 $0.08 109.61987 $0.08 113.61988 $0.08 118.31989 $0.08 1241990 $0.08 130.71991 $0.09 136.21992 $0.09 140.31993 $0.09 144.51994 $0.09 148.21995 $0.09 152.41996 $0.09 156.91997 $0.09 160.5

Add a column with CPI for each year◦ CPI.xls

Then…Calculate the

1997 equivalent value for each price

1997 CPI value will remain constant in each equation

Make it an absolute reference by pressing F4 on the keyboard

Fill to the bottom

The new Graph

1984 1986 1988 1990 1992 1994 1996 1998$0.080

$0.085

$0.090

$0.095

$0.100

$0.105

$0.110

$0.115

1997 Constant $ Value

Calculating Inflation RateInflation rate is defined as

◦the percentage change in the CPIs from the previous year to the next.

◦Inflation Rate in 2008 was 2008 CPI – 2007 CPI

2007 CPI 215.3-207.3 = .0386 or 3.86%

207.3