Consumer Price IndexCPI

Inflation

• The general increase of the price of goods over time

• No obvious quality improvement• Okay as long a our income increases

at same rate or higher• If not, not as well off as we think• Also important - financial planning

– $100 today will not buy as much in 20 years

Inflations Effect on $1.00

• How do we compare prices of today with those of the past?

• How do we measure inflation?

Consumer Price Index (CPI)

• Way to compare prices in different years

• Economists 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

• The cost of the bundle is assigned an index number

• The following year the cost of the same bundle is determined

• CPI for that year = new cost of bundle

Official CPI 1990-2010

YearCPI

1982-84=1001990 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 215.32009 214.5

• 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

Can calculate how many times more the prices of goods were in one year than another

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 Dollars

Comparing amounts from 2 different years

Can convert any money related variables◦Prices, wages, salaries

Current prices for each year are called nominal

Compare prices taking changing value of money into account

Convert one price to same year as other◦Usually convert forward to more recent year

The Formula

• The general formula for converting to constant dollars :

• (New CPI) / (Old CPI) * (Old Price) = Price in constant dollars

Another Example

• Your boss said she made $25,000 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 2010)? 

Compare Prices in Consecutive Years

• Convert entire series of prices to constant dollars

• Use Excel

Electricity Prices1986 - 1997Electricity 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

Is this a realistic depiction of the price of electricity?

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 (freeze it) by pressing F4 on the keyboard

• Fill to the bottom

CPI Graphs

Time (years)

Change over time

Time (years)

Change over time

$ increases at same rate as inflation (ex. Milk, bread, salary)

$ increases slower than inflation (ex. electricity)

$ increases faster than inflation (ex. Gas or cigarettes)

Calculating Inflation Rate

• Inflation 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