Consumer Price Index What prices have changed over

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: $0. 05 for a Hershey bar n $0. 05 for a copy of New York Times n $0. 04 for first class postage stamp n $0. 31 for gallon of regular gas n $0. 28 for Mc. Donalds double hamburger n $2, 529. 00 for full-size Chevrolet n

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?

n To answer this, you need a way to standardize prices (and wages), so that you can compare across time.

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

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

Computation of CPI n An army of economists gathers prices on a standard “market basket” of goods at fixed time periods (month, year). n The prices of the baskets is compared.

Computation of CPI n An army of economists gathers prices on a standard “market basket” of goods at fixed time periods (month, year). n The prices of the baskets is compared. n The prices are converted to index numbers.

What’s in the CPI? Housing (41. 4%) n Transportation (17. 8%) n Food (16. 2%) n Energy (8. 2%) n Medical Care (6. 4%) n Apparel & Upkeep (6. 1%) n Other (3. 9%) n

Current CPI n NYTimes Graphic

Creating the CPI Cost of bundle in a base year = 100 (on index) n Cost of the bundle for other years is then calculated n Ex: 1982 = base year; bundle = $1103. 46 n In 1983, bundle = $1138. 91 n SO: $1138. 91 (1983) = $1103. 46 (1982) n

OR: $1138. 91 (1983) = $1103. 46 (1982) n Then 1 (1982$) = 1138. 91/1103. 46 =1. 032 (1983$) n So… 1 (1982$) = 1. 032 (1983$) n 1982 = base year; index = 100 n 1983; index = 103. 2 n

And we get an INDEX n n n n n Year 1980 1981 1982 1983 1984 1985 1986 1987 n n n n n CPI 85. 4 94. 2 100. 0 103. 2 107. 7 111. 5 113. 6 117. 7

FORMULA for the Conversion Factor n 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 1990, gas costs $1. 16/gallon (on avg) n 1997, gas costs $1. 23/gallon (on avg) n n Was gas more or less expensive in 1997? Nominal price (current price) = MORE n But, what about in constant/real $? n

Converting Prices n 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 Conversion Factor n = CPI of base year/CPI of object year n 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 Remember that you can “freeze” the value in a cell so that the reference stays the same n When you convert prices, you want to freeze the value of the base year (1998) n F 4 freezes the value – B 2*$C$10/C 2 n

Additional terminology: n Current values (prices, wages, etc. ) are prices (nominal values) at the value of the currency at that time n Constant values (prices, etc. ) are prices in real values, i. e. , as if the currency had the value of the base year.

Inflation Rate Percentage Change in the annual CPI n Ex: Inflation Rate in 1996: n