LSP 120 CPI (Consumer Price Index)

Prices Have Changed!  What do you remember?  Try the simple example on 120/cpi.htm 120/cpi.htm 120/cpi.htm  So is a $ today the same as a $ yesterday?  Why do we care? What do you do when someone tells you something cost $X twenty years ago? What about your salary?

Index Numbers  How is the buying power of $1.00 measured?  How can we compare prices of items in different years?  Use a price index or simply an index number

Index Numbers  How do you create an index number?  Working with a series of years and prices, choose a base period and set it to 100.  Percentage increases (or decreases) from this base period are then calculated.  For example, consider the average price of bread from :

Year Average Price of White Bread per pound (US City Average) 1980$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $0.89

Year Average Price of Bread White Bread Index (1980=100) 1980$ $ $ $0.54 Let’s make 1980 the base year.

We want the index to reflect the ratio of bread prices from a given year to the price in Thus Price in 1981Index for 1981 Price in 1980= 100 or 0.53=Index for Index for 1981 = (0.53 / 0.51) * 100 = (What is this?? “Times more” changed to a percentage!) Similarly, for 1982 we use the ratio back to 1980: Price in 1982Index for 1982 Price in 1980= 100 The complete index number table will look like:

Year Average Price of White Bread per pound (US City Average) White Bread Index (1980=100) 1980$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

Index Numbers  The neat thing about the index is how easy it is to see the percentage of increase of a price from the base year  How much more did bread cost in 1992 than it did in 1980?  What is the percentage change from 1989 to 1999? ( )/130.8 = 33.1%

Consumer Price Index  An index is great for a particular item, but what about inflation in general?  This is where the Consumer Price Index comes into play.  The Bureau of Labor Statistics created an imaginary “market basket” of goods that an average family needs

CategoryWeighting Housing39.6% Transportation17.6% Food16.3% Entertainment6.1% Medical Care 5.6% Education and Communication 5.5% Apparel and Upkeep 4.9% Other4.3%

Consumer Price Index  The table on the next slide shows the official CPI since 1982 (it actually goes back to 1912).  Note that the base price was not taken from one year but taken from the average of three years: 1982 – 1984.

YearCPI ( = 100) Think of the CPI as the amount the average consumer would have to spend in a given year to buy the same basic goods and services that one would have to pay $100 for in the base period.

How Do We Use the CPI?  In 1990, gasoline cost $1.16 per gallon (on average). In 1997, the average price was $1.23. Did the cost of gasoline go up or go down?  $1.16 and $1.23 are called current prices. According to these current prices, it looks like gas got more expensive. Is this accurate?  Let’s compare the prices taking into account the changing value of money

We wish to know: $1.16 in 1990 dollars is equivalent to x in 1997 dollars? (1997 CPI)x (1997 dollars) (1990 CPI)=1.16 (1990 dollars) x = ( / ) * 1.16 x = 1.42 So when Americans paid $1.16 per gallon for gasoline in 1990, it was equivalent to someone paying $1.42 in 1997, which is considerably more than what they were actually paying in 1997 ($1.23). The $1.42 value is what we call constant dollars. The price of gasoline was cheaper in 1997 than in 1990!

Or look at it this way: The ratio of equals This is how many times more one 1990 dollar was worth in So multiply the 1990 price of $1.16 by this ratio (1.228) and you will get the value $1.42.

Let’s Try Another One  A 1966 Schwinn 5-Speed Fastback bicycle cost $69.95  What would that cost today?

Let’s Try Another One  Divide 2010 CPI by 1966 CPI and multiply by $69.95  (218.1 / 32.4) * = $470.87

More Uses of CPI  You can use the CPI to convert an entire series of prices to constant dollars  Consider the price of electricity from 1990 to 1998: Year Avg Cost Electricity Per kWh 1990$ $ $ $ $ $ $ $ $0.087

More Uses of CPI  In graphical form, the data looks like:

Inflation  Inflation is defined as the percentage increase in the CPI for a given year  For example, the CPI in 1997 was 160.5; in 1998 it was  The inflation rate for 1998 was (163.0 – 160.5) = 1.6%

What is Your Salary History?

Salary in Constant Dollars Years Salary Are you gaining income, losing income, or staying even?