Measuring Inflation
The Consumer Price Index
Background
The Bureau of Labor Statistics (BLS) surveys
30,000 households on their spending
habits. It uses this information to
construct a market basket of 211 types of
goods and services purchased by the
typical urban family of four.
Background
Each month the BLS visits 23,000 stores in
87 cities and collects price information for
the goods and services in the market
basket.
Definition
This information is weighted to construct the
Consumer Price Index (CPI):
An average of the prices of the goods and
services purchased by the typical urban
family of four, or a measure of the overall
average price level faced by consumers.
Movieville
Suppose we live in Movieville and our hypothetical
market basket is made up of movie related
goods and services.
Caclulating Our “CPI”
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We first need to determine the base year.
Suppose we choose the base-year to be
2006
The quantities purchased in 2007 and
2008 are irrelevant, because we are
assuming the household buys the same
market basket of goods each month.
Calculate Expenditures on BaseYear Quantities (2006)
For the CPI we use “Current Prices” and
“Constant Quantities”.
P2006 x Q2006 =
(12 x $8.00) Movie Tickets
(6 x $4.00) Popcorn
(10 x $2.50) Soda
= $145.00
Calculate the Cost of the Market
Basket in 2007
For the CPI we use “Current Prices” and
“Constant Quantities”.
P2007 x Q2006 =
(12 x $10.00) Movie Tickets
(6 x $5.00) Popcorn
(10 x $3.00) Soda
= $180.00
Calculate the Cost of the Market
Basket in 2008
For the CPI we use “Current Prices” and
“Constant Quantities”.
P2008 x Q2006 =
(12 x $12.00) Movie Tickets
(6 x $5.50) Popcorn
(10 x $3.50) Soda
= $212.00
To calculate the CPI we use the
following formula:
Expenditures _ in _ the _ Current _ Year
CPI 
 100
Expenditures _ in _ the _ Base _ Year
CPI 
Cost _ of _ Basket _ in _ Current _ Year
 100
Cost _ of _ Basket _ in _ Base _ Year
Calculate the CPI for 2006
CPI2006 = (Cost of Basket2006/Cost of Basket2006) x 100
CPI2006 = (145/145) x 100 = 100
The value of the CPI is always equal to 100 in the baseyear.
As with the GDP deflator, the CPI gives us an index
number, there are no units.
Calculate the CPI for 2007 and 2008
CPI2007 = (Cost of Basket2007/Cost of Basket2006) x 100
CPI2007 = (180/145) x 100 = 124.14
CPI2008 = (Cost of Basket2008/Cost of Basket2006) x 100
CPI2008 = (212/145) x 100 = 146.21
Calculating the Inflation Rate from
the CPI
Remember, the CPI is a measure of the average
overall price-level, not the inflation rate.
To Calculate the inflation rate we use our growth
rate formula.
New _ Value  Old _ Value
Percent_ Change % 
 100
Old _ Value
Calculate the inflation rate from 2006
to 2007 and from 2007 to 2008
Inflation06-07 = [(CPI2007 – CPI2006)/CPI2006] x 100
Inflation06-07 = [(124.14 – 100)/100] x 100
Inflation06-07 = 24.14%
Inflation07-08 = [(CPI2008 – CPI2007)/CPI2007] x 100
Inflation07-08 = [(146.21 – 124.14)/124.14] x 100
Inflation07-08 = 17.78%
The CPI Over Time
Two Types of Inflation
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
Top-Line (Headline) Inflation: The inflation
rate as calculated from the CPI for all
urban consumers for All Items.
Core Inflation: The inflation rate as
calculated from the CPI for all urban
consumers Less Food and Energy.
Top-Line and Core Inflation, 1957 to 2009
Top Line and Core Inflation
25.000
Top Line
20.000
Core
15.000
5.000
0.000
-5.000
-10.000
-15.000
-20.000
Time
Jan-08
Jan-05
Jan-02
Jan-99
Jan-96
Jan-93
Jan-90
Jan-87
Jan-84
Jan-81
Jan-78
Jan-75
Jan-72
Jan-69
Jan-66
Jan-63
Jan-60
-25.000
Jan-57
Percent
10.000
Using the CPI to adjust for inflation
Example: Babe Ruth was paid $80,000 in
1930. How much would that be worth in
2009 dollars? The CPI in 1930 was
approximately 16.5 and the CPI in 2009 is
215.8.
Converting to “Today’s Dollars”
General Formula
Value in Year X Dollars =
(Value in Year Z Dollars) x (CPI in Year X/CPI in Year Z)
Our Example
Value in 2009 Dollars
= Value in 1930 Dollars x (CPI2009/CPI1930)
Value in 2009 Dollars
= $80,000 x (215.8/16.5)
= $1,046,303.03
Interpretation
This tells us that if you were paid
$1,046,303.03 today, you would be able to
purchase roughly the same amount of
goods and services Babe Ruth could have
purchased in 1930 with a salary of
$80,000. This calculation adjusts a
nominal variable, the Babe’s salary for the
effects of inflation.
Nominal and Real Values
We can also use the CPI to convert nominal
values to real values using the following
formula:
Real Value in Base Year Dollars =
[(Nominal Value in Year X)/(CPI in Year X)] x 100
Our Base Year
Note that our current CPI uses the “baseyear” 1982-84, so everything is in 1982-84
dollars.
The basket used to be updated every 10
years and is now updated every 2 years,
but the “base-year” 1982-84 remains.
Historical Gasoline Prices
Converting the Price of Gasoline
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We can use the formula from above to
convert the price of gasoline to the “real”
price of gasoline in 1982-84 dollars.
We can also convert all of the gasoline
prices to 2009 dollars.
Calculate the Real Price of Gasoline
for 1950
Real Price in Base Year Dollars =
[(Nominal Value in 1950)/(CPI in 1950)] x 100
The 1950 Real Price of Gas in 1982-84 Dollars =
[($0.27/24.0)] x 100 = $1.13
Convert the 1950 Price of Gasoline
to 2009 Dollars
Price of Gas in 2009 Dollars =
(Price of Gas in 1950) x (CPI in 2009/CPI in 1950)
Price of Gas in 2009 Dollars =
($0.27) x (215.8/24) = $2.43
Historical Gasoline Prices