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Economists use Consumer Price Index [CPI] to estimate real wages and costs from nominal wages and costs.

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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Economists use Consumer Price Index [CPI] to estimate real wages and costs from nominal wages and costs.

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  1. Economists use Consumer Price Index [CPI] to estimate real wages and costs from nominal wages and costs.

  2. Computation of CPI • An army of economists gathers prices on a standard “market basket” of goods at fixed time periods (month, year)

  3. Computation of CPI • 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.

  4. Computation of CPI • 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.

  5. The CPI can be used to adjust economic data to remove the effect of changing underlying prices.

  6. Suppose that CPI for three years is as follows:Year 1 50Year 2 100Year 3 200

  7. Year 1 CPI= 50Year 2 CPI= 100Year 3 CPI= 200That is, things cost twice as much, on average, in Year 2 (Y2) as in Year 1 (Y1).So, $1.00 could buy twice as much as in Year 1 (Y1) as in Year 2 (Y2).So, the value of the Y1 dollar is twice that of the Y2 dollar

  8. Relative values can be computed using this formula:CPI of base year / CPI of object year * 100(Object year is the year being compared to the base year)

  9. Let’s refer to the formulaCPI of base year / CPI of object yearas a formula for a conversion factor

  10. Conversion factor = CPI of base year / CPI of object year

  11. Use the conversion factor to adjust the prices:Price * conversion factor = adjusted price

  12. Using previous terminology:Nominal price * conversion factor = real price (relative to base year)

  13. Combining the formula for adjusted price with that for the conversion factor:Nominal price * (CPI base year / CPI object year) = real price

  14. Additional terminology: • 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.

  15. Problem:In 1930, Babe Ruth earned his maximum salary: $80,000.How does this compare with today’s salaries?

  16. 2007 average salary:$2,944,556Highest paid player:Alex Rodriguez @$23,428,571

  17. What would the average salary and A-Rod’s salary have been in constant (1930) dollars?What would Babe Ruth’s salary have been in constant (2006) dollars?

  18. Babe Ruth: $80,0002007 average: $2,944,556 Alex Rodriguez: $23,428,571

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