The Measurement and Calculation of Inflation Market Baskets and Price Indices

“Prices are up… I think.” “Eggs are up. Gas is down. Jeans are up. Cell phones are down.” How exactly do we measure if “prices” are up? Aggregate price level To calculate the aggregate price level, we need a price index. To calculate a price index, we need a market basket A hypothetical set of consumer purchases of goods and services

Example: A Market Basket from the Deli Item in the Market Basket Quantity Consumed in a Typical Year (pounds) 2011 prices (per pound) 2012 prices (per pound) 2013 prices (per pound) 2014 prices (per pound) Salami300$4.00$6.00$6.50$7.50 Corned Beef200$5.00$7.00$7.50$7.00 Bologna100$2.00$1.50$1.25$1.00 Cheese500$3.00$2.50$2.00$1.00 Did inflation occur between 2011 and 2012? Notice that some prices went up, some down. How do we find out? We have to determine if the market basket became more or less expensive to purchase. (Let’s calculate this). Over time, we could create the “Deli Price Index” (DPI) to compare the market baskets from different years. How do we calculate how MUCH inflation there was in 2012? Cost of market basket in base year Price Index in a given year= Cost of market basket in a given year X 100 Price index in year 1 Inflation Rate = Price index in year 2 – Price index in year 1 X 100

Price Indices Consumer Price Index (CPI) Computed every month on a market basket of 80,000(!) goods and services that a typical urban family of four consumes. Producer Price Index (PPI) Measures the cost of a typical basket of goods and services—containing raw commodities such as steel, electricity, coal, and so on—purchased by producers. GDP Deflator Technically not a price index, but used the same way. The GDP deflator for a given year is equal to 100 times the ratio of the nominal GDP for that year to real GDP for that year expressed in prices of a selected base year. Example: Real GDP is expressed in 2000 dollars, so the GDP deflator for 2000 is 100. If nominal GDP were to increase by 5%, but real GDP does not change, the GDP deflator indicates that the aggregate price level increased by 5%.

“Back in MY day…!!!” So exactly how much WOULD that have cost back in your day? The Bureau of Labor Statistics Inflation Calculator The Bureau of Labor Statistics Inflation Calculator