Consumer Price Index CPI

Consumer Price IndexCPI Week 7 LSP 120 Joanna Deszcz

Prices • Name some prices that have changed in your lifetime • Prices that have increased • Prices that have decreased • An Example • Guess the Price

Percentage Increase 1962-1998 How does the quality of each item compare from 1962 to 1998?

What have we learned so far? • Prices can and do change dramatically in relatively short periods • Price from the past can become virtually meaningless • Prices of items do not go up consistently • Some go up faster than others • Items change over time • Becomes difficult to compare prices because the items are not really comparable

Inflation • The general increase of the price of goods over time • No obvious quality improvement • Okay as long a our income increases at same rate or higher • If not, not as well off as we think • Also important to financial planning • $100 today will not buy as much in 20 years

Inflations Effect on $1.00

Some questions • How do we compare prices of today with those of the past? • How do we measure inflation?

Consumer Price Index • Way to compare prices in different years • Economists choose a “bundle” or “basket” of goods in varying proportions

CPI Continued • The cost of the bundle is assigned an index number • The following year the cost of the same bundle is determined • CPI for that year = new cost of bundle

Official CPI 1990-2008 Initial Index value = 100 and represents average CPI of 1982-84 • How to read the table • Used to compare prices of any two years • Example: same goods that cost $130.70 in 1990 would cost $172.20 in 2000 • So $130.70 in 1990 = $172.20 in 2000

Relationship Between Factors • Can calculate how many times more the prices of goods were in one year than in a • Calculate the ratio of the CPI values • So, goods in 2000 cost 1.302 times more than in 1990 (on average) 2000 CPI = 170.2 = 1.302 1990 CPI 130.7

Converting to Constant Dollars • Comparing amounts from 2 different years • Can convert any money related variables • Prices, wages, salaries • Current prices for each year are called nominal • Compare prices taking changing value of money into account • Convert one price to same year as other • Usually convert forward to more recent year

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? • 1990 $130.70 equivalent to $160.50 in 1997 • 1997 CPI = 160.5 = 1.231990 CPI 130.7 • So $1.00 in 1990 = $1.23 in 1997 • Multiply 1990 value by 1.23 (1.16 * 1.23) • So $1.16 in 1990 = $1.42 in 1997

Another Example • Your instructor said she made $22,000 a year at her first job out of college in 1993. That doesn't sound like a lot of money to us today, but we must consider that everything was less expensive in 1993. • What is that salary worth in today's money (in 2008)?

Compare Prices in Consecutive Years • Convert entire series of prices to constant dollars • Use Excel

Electricity Prices1986 - 1997

As a Graph… Is this a realistic depiction of the price of electricity?

Huh? • Did price of electricity increase really? • Value of dollar deceased each year • Nominal cost increased • What about constant dollars? • Convert 1986 values to 1997 dollars tp find out

Here’s how… • Add a column with CPI for each year • CPI.xls

Then… • Calculate the 1997 equivalent value for each price • 1997 CPI value will remain constant in each equation • Make it an absolute reference by pressing F4 on the keyboard • Fill to the bottom

The new Graph

Calculating Inflation Rate • Inflation rate is defined as • the percentage change in the CPIs from the previous year to the next. • Inflation Rate in 2008 was • 2008 CPI – 2007 CPI 2007 CPI • 215.3-207.3 = .0386 or 3.86% 207.3

Consumer Price Index CPI