Transcript CPI

Consumer Price Index
What prices have
changed over your
lifetime?
What items cost more?
What items cost less?
Question: How do we
know if something “really”
costs more?
First, we need correct
terminology.
Nominal price:
list or actual cost
given current value of
money
Nominal price:
Useful for comparisons
within same time period
and in same location
Problem with nominal
prices:
Cannot make meaningful
comparisons of prices
across time periods
or locations.
Prices of products in
1962:
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$0.05 for a Hershey bar
$0.05 for a copy of New York Times
$0.04 for first class postage stamp
$0.31 for gallon of regular gas
$0.28 for McDonalds double
hamburger
$2,529.00 for full-size Chevrolet
Why can’t one compare
1962 prices with prices for
same or similar products
today?
More precisely, why are
such comparisons
meaningless?
Real price:
Cost relative to general
economic conditions
in a place and time.
Why?
Because the price of an item
only has meaning in terms
of what one passes up to
buy it.
Similarly with wages:
Income only can be
evaluated in terms of what
can be purchased with it.
Inflation:
A general rise in prices in an
economy.
Deflation:
A general decrease in prices
in an economy.
Inflation and deflation
create disparities
between real and nominal
prices.
Suppose a young person
gets an allowance of $10
per week.
Her allowance allows her a
certain level of
consumption.
Suppose that the prices of
goods she normally buys
increase by 20% and her
father increases her
allowance to $11.
Has her allowance
increased?
Answer:
Her nominal allowance
has increased but
her real allowance
has decreased.
Key Question: Are people
better off now than they
used to be?
 To
answer this, you need a
way to standardize prices
(and wages), so that you
can compare across time.
CPI: Consumer Price
Index
 Economists
use
Consumer Price Index
[CPI]
to estimate real wages and
costs from nominal wages
and costs.
Computation of CPI

An army of economists gathers prices
on a standard “market basket” of
goods at fixed time periods (month,
year)
Computation of CPI

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An army of economists gathers prices
on a standard “market basket” of
goods at fixed time periods (month,
year).
The prices of the baskets is compared.
Computation of CPI
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An army of economists gathers prices
on a standard “market basket” of
goods at fixed time periods (month,
year).
The prices of the baskets is compared.
The prices are converted to index
numbers.
What’s in the CPI?
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Housing (41.4%)
Transportation (17.8%)
Food (16.2%)
Energy (8.2%)
Medical Care (6.4%)
Apparel & Upkeep (6.1%)
Other (3.9%)
Current CPI
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NYTimes Graphic
Creating the CPI
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Cost of bundle in a base year = 100
(on index)
Cost of the bundle for other years is
then calculated
Ex: 1982 = base year; bundle =
$1103.46
In 1983, bundle = $1138.91
SO: $1138.91 (1983) =
$1103.46 (1982)
OR:
$1138.91 (1983) = $1103.46 (1982)
 Then 1 (1982$) = 1138.91/1103.46
=1.032 (1983$)
 So…1 (1982$) = 1.032 (1983$)
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1982 = base year; index = 100
1983; index = 103.2
And we get an INDEX
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Year
1980
1981
1982
1983
1984
1985
1986
1987
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CPI
85.4
94.2
100.0
103.2
107.7
111.5
113.6
117.7
FORMULA for the Conversion Factor
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Notice that those relative values can be
computed using this formula:
CPI of base year / CPI of object year
(Object year is the year being compared to
the base year)
Conversion factor =
CPI of base year / CPI of object
year
Use the conversion factor to
adjust the prices:
Price * conversion factor =
adjusted price
An Example
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1990, gas costs $1.16/gallon (on avg)
1997, gas costs $1.23/gallon (on avg)
Was gas more or less expensive in
1997?
Nominal price (current price) = MORE
But, what about in constant/real $?
Converting Prices
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From the CPI table, we know that
$130.70 (1990) = $160.50 (1997)
If something costs $1.16 in 1990, what
would that amount to in 1997?
160.50 (1997) = x (1997 $)
130.70 (1990)
1.16 (1990 $)
Another way to think of
this
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Conversion Factor
= CPI of base year/CPI of object year
160.50
130.70
(how much more one dollar in 1990 is worth
in 1997)
=1.228 * $1.16 = $1.42
So, $1.16 in 1990 = $1.42 in 1997
Using previous terminology:
Nominal price * conversion factor =
real price (relative to base year)
Combining the formula for adjusted
price with that for the conversion
factor:
Nominal price * (CPI base year / CPI
object year) = real price
Another Example
Converting Prices in Excel
Freezing the Cell
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Remember that you can “freeze” the
value in a cell so that the reference
stays the same
When you convert prices, you want to
freeze the value of the base year
(1998)
F4 freezes the value – B2*$C$10/C2
Additional terminology:
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Current values (prices, wages, etc.)
are prices (nominal values) at the
value of the currency at that time
Constant values (prices, etc.) are
prices in real values, i.e., as if the
currency had the value of the base
year.
Inflation Rate
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Percentage Change in the annual CPI
Ex: Inflation Rate in 1996: