Consumer Price Index

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Consumer Price Index
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What prices have changed over your lifetime?

• What items cost more?
• What items cost less?

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Question How do we know if something really
costs more?
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First, we need correct terminology.
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Nominal pricelist or actual cost given
current value of money
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Nominal priceUseful for comparisons within
same time periodand in same location
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Problem with nominal pricesCannot make
meaningful comparisons of prices across time
periods or 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 double hamburger
• 2,529.00 for full-size Chevrolet

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Why cant one compare 1962 prices with prices for
same or similar products today? More
precisely, why are such comparisons meaningless?
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Real priceCost relative to general economic
conditions in a place and time.
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Why?Because the price of an item only has
meaning in terms of what one passes up to buy it.
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Similarly with wagesIncome only can be
evaluated in terms of what can be purchased with
it.
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InflationA general rise in prices in an
economy.
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DeflationA general decrease in prices in an
economy.
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Inflation and deflationcreate disparities
between real and nominal prices.
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Suppose a young person gets an allowance of 10
per week. Her allowance allows her a certain
level of consumption.
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Suppose that the prices of goods she normally
buys increase by 20 and her father increases her
allowance to 11.
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Has her allowance increased?
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AnswerHer nominal allowance has increased
buther real allowance has decreased.
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Key Question Are people better off now than they
used to be?
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• To answer this, you need a way to standardize
  prices (and wages), so that you can compare
  across time.

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CPI Consumer Price Index

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

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Computation of CPI

• An army of economists gathers prices on a
  standard market basket of goods at fixed time
  periods (month, year)

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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.

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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.

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Whats in the CPI?

• Housing (41.4)
• Transportation (17.8)
• Food (16.2)
• Energy (8.2)
• Medical Care (6.4)
• Apparel Upkeep (6.1)
• Other (3.9)

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Current CPI

• NYTimes Graphic

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Creating the CPI

• Cost of bundle in a base year 100 (on index)
• Cost of the bundle for other years is then
  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)
• So1 (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 be computed
  using this formulaCPI of base year / CPI of
  object year (Object year is the year being
  compared to the base year)

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Conversion factor CPI of base year / CPI of
object year
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Use the conversion factor to adjust the
pricesPrice 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 in 1997?
• 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, what would 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 terminologyNominal price
conversion factor real price (relative to
base year)
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Combining the formula for adjusted price with
that for the conversion factorNominal price
(CPI base year / CPI object 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 the value 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 B2C10/C2

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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.

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Inflation Rate

• Percentage Change in the annual CPI
• Ex Inflation Rate in 1996