1. Inflation Part 3

2. The USA has experienced an average inflation rate of 2.22% per year.
Prices in 2016 are 84.0% higher than in 1990.
Bottom Line: $100 in 1994 is equivalent to $184 in 2016
The inflation rate in 2016 was 1.26%.

3. Why Inflation is Bad? Difficult for Business to plan for future
price goods/services unclear
Investment becomes difficult
Lowers value of U.S. currency
Lowers purchasing power (real value of money)
Raises long term interest rates
10-year Gov’t Bond = 2.30%
Bond buyers would need more nominal interest!

4. Review: CPI Price Index
Measurement of Consumer Inflation
Consumer Market Basket
of goods/services
Year CPI Index
Pick a
base year
[(Ending Index – Beginning Index) / Beginning Index] * 100

5. Calculating a CPI Index (video)

6. Problems with CPI Index
Substitution Bias
New goods
Unmeasured quality changes
Housing Measurement
Basket must “evolve”
with the market

7. Adjusting numbers for inflation
Ending Index (2005)
Base Year Index (1931)
X Old Dollar Value (1931) = dollars
1931 Salary = $80, CPI =
CPI =
Convert Babe Ruth’s wages in 1931 to 2005 dollars:
195
15.2
X $80,000 = 1,026,316 (2005 dollars)
Conclusion:
Top baseball players earn 16 times more
in real terms than players from 1931

8. The Most Popular Movies of All Times, (Inflation Adjusted)

9. Practice Problem Year CPI Index 1994 146 2016 236
CPI in 2016
CPI in * 1994 USD value = USD value
What was the inflation rate from 1994 to 2016?
You made $500,000 year in 1994, what is the equivalent pay in 2016?
You made $70,000 in 2016, what is the equivalent pay in 1994?

10. Practice Test