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Unit 2

2.4 Price Indices and Inflation

2 min readnovember 18, 2020

Jeanne Stansak

caroline49234295

Caroline Koffke


2.4: Price Indices and Inflation

Vocabulary

Consumer Price Index—a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. (Source: investopedia.com). The basket of consumer goods that we are talking about is a sample of goods and services that are typically bought by your average household.
Inflation—the general rising of prices in a market or aggregate economy over time.
Deflation—the general decrease of prices in a market or aggregate economy over time.
Disinflation—a decrease in the rate of inflation
Inflation Rate—the percent change in aggregate price level across an entire economy in one year.
Real variables—variables where the effects of inflation have been factored out.

How to Calculate the CPI

Formulas

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Sample Problem

United States Market Basket - 2016
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United States Market Basket - 2017
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United States Market Basket - 2018
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The first step in calculating either the CPI or the inflation rate is to figure out the value of each market basket. Once you have calculated the market basket, then you can figure out both the CPI for each year and the inflation rate from year to year.
To find the value of the market basket for each year, you simply multiply Price x Quantity for each good and then add all those amounts together. Let's use 2016 as the base year in this example.
Market Basket Value for 2016 = ($3 x 10) + ($2 x 10) + ($5 x 10) = $100
Market Basket Value for 2017 = ($3.25 x 10) + ($3.50 x 10) + ($5.25 x 10) = $120
Market Basket Value for 2018 = ($3.50 x 10) + (3.50 x 10) + (5.50 x 10) = $125
💡When calculating the CPI for the base year, you are always going to get a 100 as the answer. The reason for this is because you divide the value of the market basket for the base year by itself.
2016 CPI = ($100/$100) x 100 = 100
2017 CPI = ($120/$100) x 100 = 120
2018 CPI = ($125/$100) x 100 = 125
2017 Inflation Rate = ((120-100)/100) x 100 = 20%
2018 Inflation Rate = ((125-100)/100) x 100 = 25%

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