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Unit 2

2.4 Price Indices and Inflation

2 min readโ€ขnovember 18, 2020

Jeanne Stansak

Caroline Koffke


2.4: Price Indices and Inflation

Vocabulary

Consumer Price Indexโ€”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.

Inflationโ€”the general rising of prices in a market or aggregate economy over time.

Deflationโ€”the general decrease of prices in a market or aggregate economy over time.

Disinflationโ€”a decrease in the rate of inflation

Inflation Rateโ€”the percent change in aggregate price level across an entire economy in one year.

Real variablesโ€”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

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-lGX1LNoNCxIE.png?alt=media&token=5b037a5a-cb27-44a0-9c36-3f1ae303b288

United States Market Basket - 2017

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-0XSxRqKXc6im.png?alt=media&token=79b55e0b-4d0c-48ab-ae90-38abf088e319

United States Market Basket - 2018

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-XUzi0kG56Sxe.png?alt=media&token=08fb2ff7-674c-4d13-ac6f-8ce9d09b1dd7

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

๐Ÿ’กWhen 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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