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

2. 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.

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

4. 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

5. 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%

6. 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 $1103.46. In 1983 that same bundle cost $1138.91. This means in terms of the bundle chosen,  1103.46 (1982 $)= 1138.91 (1983 $)  Proportionally, this means  1 (1982 $)= 1138.91/1103.46 (1983 $)  = 1.032 (1983 $)

7. Continue this process YearCPI 198085.4 1981 94.2 1982100.0 1983103.2 1984107.7 1985111.5 1986113.6 1987117.7 1988122.6

8. So what now..  The beauty of this table is that we can easily compare any two years prices, not just a given year and 1982. For example, from the table we can see that in 1980, it would cost $85.40 for goods and services costing $100 in 1982.  But also from the table we can see that in 1990, it would cost $135.40 for goods and services costing $100 in 1982.  Therefore, in 1980, $85.40 would buy the same goods and services (on average) as $135.40 would in 1990.  We say that $85.40 in 1980 is equivalent to $135.40 in 1990, or 85.40 (1980 $) is equivalent to 135.40 (1990 $).

9. Using the CPI  The Table below shows the official CPI since 1982. We will explore how it is used. YearCPI 198296.5 198399.6 1984103.9 1985107.6 1986109.6 1987113.6 1988118.3 1989124.0 1990130.7 1991136.2 1992140.3 1993144.5 1994148.2 1995152.4 1996156.9 1997160.5 1998163.0

10. 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 1997. Economists refer to prices from a given year as nominal or current prices. Nominally, gas was more expensive in 1997.

11. 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:

12. Year Average Cost of Electricity per kWh 1990$0.084 1991$0.087 1992$0.088 1993$0.092 1994$0.092 1995$0.094 1996$0.094 1997$0.094 1998$0.087

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