### Consumer Price Index CPI

```Consumer Price Index
CPI
Week 7
LSP 120
Joanna Deszcz
Prices

Name some prices that have changed in
◦ Prices that have increased
◦ Prices that have decreased

An Example
◦ Guess the Price open using Internet Explorer
Percentage Increase 1962-1998
Item
Hershey bar
Percentage Increase in
Price
1180%
New York Times
1100%
First class postage
700%
Gasoline (gallon)
Hamburger (McDonald's
double)
Chevrolet (full size)
284%
Refrigerator freezer
60%
861%
790%
How does the quality of each item
compare from 1962 to 1998?
What have we learned so far?

Prices can/do change dramatically in
relatively short periods
◦ Price from 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 - 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

Components of the CPI(U)
Housing
41.4%
Transportation
17.8%
Food
16.2%
Energy
8.2%
Medical Care
6.4%
Apparel and Upkeep
6.1%
Other
3.9%
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 1990-2010
Initial Index value = 100 and represents average CPI of 1982-84
Year
CPI
1982-84=100
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
130.7
136.2
140.3
144.5
148.2
152.4
156.9
160.5
163.0
166.6
172.2
177.1
179.9
184.0
188.9
195.3
201.6
207.3
215.3
214.5

◦ 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
another
 Calculate the ratio of the CPI values

2000 CPI = 170.2 = 1.302
1990 CPI
130.7

So, goods in 2000 cost 1.302 times more
than in 1990 (on average)
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
\$1.22. Was gasoline more expensive or
less expensive in 1997?
◦ 1990 \$130.70 equivalent to \$160.50 in 1997
◦ 1997 CPI = 160.5 = 1.23
1990 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
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 2010)?

Compare Prices in Consecutive Years
Convert entire series of prices to
constant dollars
 Use Excel

Electricity Prices1986 - 1997
Electricity Prices (US city average, per KWH)
Year
Price
1986
\$0.077
1987
\$0.079
1988
\$0.080
1989
\$0.082
1990
\$0.084
1991
\$0.087
1992
\$0.088
1993
\$0.092
1994
\$0.092
1995
\$0.094
1996
\$0.094
1997
\$0.094
As a Graph…
Electricity Prices 1986-1997
\$0.10
\$0.10
\$0.09
Price
\$0.09
\$0.08
\$0.08
\$0.07
\$0.07
\$0.06
\$0.06
\$0.05
1984
1986
1988
1990
1992
1994
1996
1998
Year
Is this a realistic depiction of the price of electricity?
Huh?
Did price of electricity increase really?
 Value of dollar decreased each year
 Nominal cost increased
 Convert 1986 values to 1997 dollars to
find out

Here’s how…
Year
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
Price
\$0.08
\$0.08
\$0.08
\$0.08
\$0.08
\$0.09
\$0.09
\$0.09
\$0.09
\$0.09
\$0.09
\$0.09
CPI
109.6
113.6
118.3
124
130.7
136.2
140.3
144.5
148.2
152.4
156.9
160.5

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 (freeze it)
by pressing F4 on the
keyboard
 Fill to the bottom

The new Graph
1997 Constant \$ Value
\$0.115
\$0.110
\$0.105
\$0.100
\$0.095
\$0.090
1984
1986
1988
1990
1992
1994
1996
1998
CPI Graphs
\$ increases slower than
inflation (ex. electricity)
\$ increases at same
rate as inflation (ex.
Change over
time
Change
over time
Time (years)
Time (years)
\$ increases faster
than inflation (ex.
Gas or cigarettes)
Change
over time
Time (years)
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
207.3
= .0386 or 3.86%
Negative Inflation (or Deflation)
When the price of goods drops over time
 Not always good
 Example:

◦
◦
◦
◦

2008 new car costs \$30,000
2009 expected value is \$15,000
2010 expected value is \$7,500
Would you purchased a car in 2008 knowing it would
cost you less in 2009 or 2010?
Result: consumers stop buying cars, wait for the
price to drop more industry dwindles
```