The Consumer Price Index A Way to Compare Prices in Different Years

Inflation  Inflation is a decline in the value of money in relation to the goods that it can buy.  It is so pervasive that it is very difficult to compare this year’s prices to last year’s, much less compare prices over decades.

Here is a graph of the buying power of $1.00 since 1938

Consumer Price Index  How is the "buying power" of $1.00 measured?  How can we compare prices of item in different years?  The answer is the use of price indices such as the consumer price index or CPI

Components of the CPI  Economists choose a base year and determine the prices of a "bundle" of goods: food, clothing, housing costs, transportation costs, services, entertainment in varying proportions. Components of the CPI(U) Housing41.4% Transportati on 17.8% Food16.2% Energy8.2% Medical Care 6.4% Apparel and Upkeep 6.1% Other3.9%

How is the CPI determined  The cost of this bundle in the base year is assigned an index number of 100. The cost of the same bundle is then determined in a different year.  For example, say that 1982 was the base year and the cost of the bundle of goods in 1982 was $ In 1983 that same bundle cost $ This means in terms of the bundle chosen,  (1982 $)= (1983 $)  Proportionally, this means  1 (1982 $)= / (1983 $)  = (1983 $)

Continue this process YearCPI

So what now..  The beauty of this table is that we can easily compare any two years prices, not just a given year and For example, from the table we can see that in 1980, it would cost $85.40 for goods and services costing $100 in  But also from the table we can see that in 1990, it would cost $ for goods and services costing $100 in  Therefore, in 1980, $85.40 would buy the same goods and services (on average) as $ would in  We say that $85.40 in 1980 is equivalent to $ in 1990, or (1980 $) is equivalent to (1990 $).

Using the CPI  The Table below shows the official CPI since We will explore how it is used. YearCPI

For Example  The 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? On the face of it, it seems that gas is more expensive in Economists refer to prices from a given year as nominal or current prices. Nominally, gas was more expensive in 1997.

Another example  Another use of the CPI is to convert an entire series of prices to constant dollars. For example, consider the price of electricity from 1990 to 1998:

Year Average Cost of Electricity per kWh 1990$ $ $ $ $ $ $ $ $0.087

 Finally, the inflation rate is defined as the percentage change in the annual CPI. For example, the inflation rate in 1996 was: