1. Consumer Price Index CPI Week 7 LSP 120 Joanna Deszcz

2. Prices Name some prices that have changed in your lifetime ◦ Prices that have increased ◦ Prices that have decreased An Example ◦ Guess the Price Guess the Price

3. Percentage Increase 1962-1998 Item Percentage Increase in Price Hershey bar1180% New York Times1100% First class postage700% Gasoline (gallon)284% Hamburger (McDonald's double) 861% Chevrolet (full size)790% Refrigerator freezer60% How does the quality of each item compare from 1962 to 1998?

4. What have we learned so far? Prices can and do change dramatically in relatively short periods ◦ Price from the past can become virtually meaningless Prices of items do not go up consistently ◦ Some go up faster than others Items change over time ◦ Becomes difficult to compare prices because the items are not really comparable

5. Inflation The general increase of the price of goods over time No obvious quality improvement Okay as long a our income increases at same rate or higher If not, not as well off as we think Also important to financial planning ◦ $100 today will not buy as much in 20 years

6. Inflations Effect on $1.00

7. Some questions How do we compare prices of today with those of the past? How do we measure inflation?

8. Consumer Price Index Way to compare prices in different years Economists choose a “bundle” or “basket” of goods in varying proportions Components of the CPI(U) Housing41.4% Transportation17.8% Food16.2% Energy8.2% Medical Care6.4% Apparel and Upkeep6.1% Other3.9%

9. CPI Continued The cost of the bundle is assigned an index number The following year the cost of the same bundle is determined CPI for that year = new cost of bundle

10. Official CPI 1990-2008 CPI Year CPI 1982-84=100 1990130.7 1991136.2 1992140.3 1993144.5 1994148.2 1995152.4 1996156.9 1997160.5 1998163.0 1999166.6 2000172.2 2001177.1 2002179.9 2003184.0 2004188.9 2005195.3 2006201.6 2007207.3 2008215.3 How to read the table ◦ Used to compare prices of any two years ◦ Example: same goods that cost $130.70 in 1990 would cost $172.20 in 2000 ◦ So $130.70 in 1990 = $172.20 in 2000 Initial Index value = 100 and represents average CPI of 1982-84

11. Relationship Between Factors Can calculate how many times more the prices of goods were in one year than in a Calculate the ratio of the CPI values So, goods in 2000 cost 1.302 times more than in 1990 (on average) 2000 CPI = 170.2 = 1.302 1990 CPI 130.7

12. Converting to Constant Dollars Comparing amounts from 2 different years Can convert any money related variables ◦ Prices, wages, salaries Current prices for each year are called nominal Compare prices taking changing value of money into account Convert one price to same year as other ◦ Usually convert forward to more recent year

13. Example The price of gasoline in 1990 was $1.16 per gallon on average. In 1997, it averaged $1.23. Was gasoline more expensive or less expensive in 1997? ◦ 1990 $130.70 equivalent to $160.50 in 1997 ◦ 1997 CPI = 160.5 = 1.23 1990 CPI 130.7  So $1.00 in 1990 = $1.23 in 1997 ◦ Multiply 1990 value by 1.23 (1.16 * 1.23)  So $1.16 in 1990 = $1.42 in 1997

14. Another Example Your instructor said she made $22,000 a year at her first job out of college in 1993. That doesn't sound like a lot of money to us today, but we must consider that everything was less expensive in 1993. What is that salary worth in today's money (in 2008)?

15. Compare Prices in Consecutive Years Convert entire series of prices to constant dollars Use Excel

16. Electricity Prices1986 - 1997 Electricity Prices (US city average, per KWH) YearPrice 1986$0.077 1987$0.079 1988$0.080 1989$0.082 1990$0.084 1991$0.087 1992$0.088 1993$0.092 1994$0.092 1995$0.094 1996$0.094 1997$0.094

17. As a Graph… Is this a realistic depiction of the price of electricity?

18. Huh? Did price of electricity increase really? Value of dollar deceased each year Nominal cost increased What about constant dollars? Convert 1986 values to 1997 dollars tp find out

19. Here’s how… YearPrice CPI 1986$0.08109.6 1987$0.08113.6 1988$0.08118.3 1989$0.08124 1990$0.08130.7 1991$0.09136.2 1992$0.09140.3 1993$0.09144.5 1994$0.09148.2 1995$0.09152.4 1996$0.09156.9 1997$0.09160.5 Add a column with CPI for each year ◦ CPI.xls CPI.xls

20. Then… Calculate the 1997 equivalent value for each price 1997 CPI value will remain constant in each equation Make it an absolute reference by pressing F4 on the keyboard Fill to the bottom

21. The new Graph

22. Calculating Inflation Rate Inflation rate is defined as ◦ the percentage change in the CPIs from the previous year to the next. ◦ Inflation Rate in 2008 was  2008 CPI – 2007 CPI 2007 CPI  215.3-207.3 =.0386 or 3.86% 207.3