# Section 5.3: Inflation and the Consumer Price Index.

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Section 5.3: Inflation and the Consumer Price Index

Current Population Survey Involves about 50,000 households Monthly survey conducted for the last 50 years. Conducted by the Bureau of Labor Statistics. Primary source of info on the US labor force. Datas used by legislatures/policy makers as important indicators of the nations economic situation.

Consider the following quote: All historical data are expressed in 1996 dollars using the Consumer Price Index; inflation was 3.0% between 1995 and 1996… Median income for all U.S. households rose 1.2% or \$410 between 1995 and 1996 to \$35,492 -- Weinberg, U.S. Census Bureau, 9/97

Making sense of the previous quote Whats inflation? Whats Consumer Price Index? What does in mean to say in 1996 dollars?

What is inflation? A simple definition of the word inflation is "an increase in the price you pay or a decline in the purchasing power of money". Overtime the costs of goods and services increase, so the value of a dollar is going to fall because a person cant purchase as much as s/he previously could. In other words, Price Inflation is when prices get higher or it takes more money to buy the same item.

Real Dollars Ex: Suppose that you earned \$40,000 in 2004 and \$44,000 in 2005. By what percentage did your salary increase? The answer gives the percentage increase in raw dollars, but not an increase in your buying power.

Real Dollars, continued In 2004 the average inflation rate was 2.8%, so the \$40,000 earned in 2004 is like earning 2.8% more or \$_____________ in 2005. In terms of real dollars how much did this persons salary increase?

What is CPI? Bureau of Labor Statistics keeps track of Consumer Price Index (CPI). CPI is a measure of inflation. BLS keeps a list of ~400 goods and services. Each year BLS randomly samples stores/companies to see how much it would cost to buy these same items. Here is a link to the market basket http://www.bls.gov/news.release/cpi.t01.htm http://www.bls.gov/news.release/cpi.t01.htm

Calculating Inflation BLS averages the prices it finds and adds up the average costs of goods & services in the basket. To find the amount of inflation, it divides the change in the sum of the average costs by the previous years sum. e.g. If the sum of average prices was \$30,000 last year and this year the sum is \$31,200 then the cost rose \$1,200. This is an increase of 4%. So 4% inflation means that it took 4% more dollars today to buy the same goods as last year.

Consumer Price Index Rather than report the total of the market basket, BLS divides the cost of the market basket by what it cost in 1983 and then multiplies by 100. BLS always uses the arbitrary cost in 1983 – but this number is constant. This calculation gives the CPI.

In 2002 the CPI was 179.9. What does this mean? In 1992 the market basket was 1.79 times as expensive as it was in 1983.

CPI can be used to adjust for inflation Divide by the CPI of the year from which you are translating and then multiply by the CPI of the year to which you are translating. CPI table is useful for converting between dollars over a time period

The Price of a Big Mac McDonalds Corp. is throwing a birthday party for the Big Mac and rolling out promotions harking back to the venerable sandwichs birth in 1968. A three-week retro-style promotion starting Wednesday will bring the Big Mac prices to the 1968 cost – 49 cents. – Minneapolis Star Tribune, 9/11/98

How much would a Big Mac purchased in 1968 cost in todays dollars? Today a Big Mac costs about \$2.90. The current CPI is 198.3 and the CPI in 1968 was 34.8. Calculate the 1968 price in 2006 dollars.

Comparing the two prices \$2.79 is not so different from \$2.90. It looks like the price of a Big Mac has held steady and that the shocking appearance of the advertised \$0.49 is mainly inflation.

What goes in the governments market basket? College tuition, lumber, real estate, health care? All in general have prices which have risen faster than inflation. OR Calculators, computers? Prices here have generally fallen.

Guidelines for Estimating Inflation Rule of Thumb: Prices have doubled every 20 years. So a new car today costing \$20,000 is roughly like \$10,000 in 1986.

Adjusted for Inflation In 1967 a newspaper cost about \$0.10 In 2006 a newspaper costs about \$0.50 So a person with a dime in 1967 had about \$0.50 in 2006 dollars. When we say in 2006 dollars we are adjusting for inflation. Dollar amounts that have been adjusted for inflation are often called real dollars.

Geographic CPI The purchasing power of a dollars varies not only with time but geographically as well. An apartment in Shippensburg is not the same price as an apartment in NYC. BLS has a CPI statistic which allows for comparison across geographic areas.

Geographic CPI See the table on pg 311. Suppose Adam is working in Atlanta earning \$50,000 and is offered a job in San Francisco which would pay him \$54,000. What is his Atlanta job worth in San Francisco dollars?

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