CPI.mwa

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http://slidepdf.com/reader/full/cpimwa 1/44

Consumer Price Index

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What prices havechanged over your

lifetime?

What items cost more?

What items cost less?

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Question: How do weknow if something “really”

costs more?

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First, we need correct

terminology.

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Nominal price:

list or actual costgiven current value ofmoney

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Nominal price:Useful for comparisonswithin same time periodand in same location

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Problem with nominal

prices:

Cannot make meaningfulcomparisons of pricesacross time periodsor locations.

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Prices of products in

1962: $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 doublehamburger

$2,529.00 for full-size Chevrolet

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Why can’t one compare

1962 prices with prices forsame or similar productstoday?

More precisely, why are

such comparisonsmeaningless?

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Real price:

Cost relative to generaleconomic conditions

in a place and time.

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Why?

Because the price of an itemonly has meaning in termsof what one passes up to

buy it.

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Similarly with wages:

Income only can beevaluated in terms of what

can be purchased with it.

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Inflation:

A general rise in prices in aneconomy.

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Inflation and deflationcreate disparitiesbetween real and nominalprices.

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Suppose a young persongets an allowance of $10per week.

Her allowance allows her a

certain level ofconsumption.

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Suppose that the prices ofgoods she normally buys

increase by 20% and herfather increases her

allowance to $11.

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Has her allowanceincreased?

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Key Question: Are people

better off now than theyused to be?

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To answer this, you need away to standardize prices(and wages), so that youcan compare across time.

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CPI: Consumer Price

IndexEconomists use

Consumer Price Index[CPI]to estimate real wages and

costs from nominal wagesand costs.

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Computation of CPI

An army of economists gathers prices

on a standard “market basket” ofgoods at fixed time periods (month,year)

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Computation of CPI

An army of economists gathers prices

on a standard “market basket” ofgoods at fixed time periods (month,year).

The prices of the baskets is compared.

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Computation of CPI

An army of economists gathers priceson a standard “market basket” of

goods at fixed time periods (month,year).

The prices of the baskets is compared.

The prices are converted to indexnumbers.

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Current CPI

NYTimes Graphic

http://www.nytimes.com/interactive/2008/05/03/business/20080403_SPENDING_GRAPHIC.html

http://www.nytimes.com/interactive/2008/05/03/business/20080403_SPENDING_GRAPHIC.html

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Creating the CPI

Cost of bundle in a base year = 100(on index)

Cost of the bundle for other years isthen calculated

Ex: 1982 = base year; bundle =

$1103.46 In 1983, bundle = $1138.91

SO: $1138.91 (1983) =

1103.46 1982

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OR:

$1138.91 (1983) = $1103.46 (1982)

Then 1 (1982$) = 1138.91/1103.46

=1.032 (1983$)

So…1 (1982$) = 1.032 (1983$)

1982 = base year; index = 100

1983; index = 103.2

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And we get an INDEX

Year

1980

1981 1982

1983

1984

1985

1986

1987

CPI

85.4

94.2 100.0

103.2

107.7

111.5

113.6

117.7

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FORMULA for the Conversion Factor

Notice that those relative values can becomputed using this formula:

CPI of base year / CPI of object year

(Object year is the year being compared tothe base year)

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Conversion factor =

CPI of base year / CPI of object year

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Use the conversion factor toadjust the prices:

Price * conversion factor =adjusted price

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An Example

1990, gas costs $1.16/gallon (on avg)

1997, gas costs $1.23/gallon (on avg)

Was gas more or less expensive in1997?

Nominal price (current price) = MORE

But, what about in constant/real $?

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Converting Prices

From the CPI table, we know that

$130.70 (1990) = $160.50 (1997)

If something costs $1.16 in 1990, whatwould that amount to in 1997?

160.50 (1997) = x (1997 $)130.70 (1990) 1.16 (1990 $)

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Another way to think of

this 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

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Using previous terminology:

Nominal price * conversion factor =

real price (relative to base year)

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Combining the formula for adjustedprice with that for the conversionfactor:

Nominal price * (CPI base year / CPIobject year) = real price

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Another Example

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Converting Prices in Excel

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Freezing the Cell

Remember that you can “freeze” thevalue 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

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Inflation Rate

Percentage Change in the annual CPI

Ex: Inflation Rate in 1996:

CPI.mwa

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