Consumer Price Index CPI

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) Housing41.4% Transportation17.8% Food16.2% Energy8.2% Medical Care6.4% Apparel and Upkeep6.1% Other3.9%

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 CPI Year CPI = How to read the table – Used to compare prices of any two years – Example: same goods that cost $ in 1990 would cost $ in 2000 – So $ in 1990 = $ in 2000 Initial Index value = 100 and represents average CPI of

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 times more than in 1990 (on average) 2000 CPI = = 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 That doesn't sound like a lot of money to us today, but we must consider that everything was less expensive in 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 Prices Electricity Prices (US city average, per KWH) YearPrice 1986$ $ $ $ $ $ $ $ $ $ $ $0.094

Is this a realistic depiction of the price of electricity ?

Here’s how… YearPrice CPI 1986$ $ $ $ $ $ $ $ $ $ $ $ Add a column with CPI for each year – CPI.xls 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 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 =.0386 or 3.86% 207.3