Unit 4: Income
Consumer Price Index
Inflation
• Definition: The general increase of prices over
time
• A two-liter of Coca-Cola cost $0.99 in the year
you were born (1995). What would that same
bottle of Coke cost you today?
• We’ll calculate the exact answer to this
question in a little bit
What Causes Inflation?
There are three main theories that describe
inflation:
• The Quantity Theory
• Demand-Pull Theory
• Cost-Push Theory
The Quantity Theory
• This theory says that inflation is caused by too
much money in the economy.
MV = PT
• M – amount of money in circulation
• V – velocity of circulation of that money
• P – average price level
• T – number of transactions taking place
M
P
Demand-Pull Theory
• This theory says that inflation happens when
the demand for goods and services exceeds
existing supplies.
• Examples:
– Organic beef is growing in popularity, and there
aren’t enough certified organic cows to meet the
growing demand ==> price of organic beef goes up
– Many people want Jordan’s artwork, but he only
makes one of each design ==> price of art increases
Cost-Push Theory
• This theory says that inflation occurs when the
cost of producing goods and services rise and
that cost gets passed on to the consumer
through higher prices.
• Examples:
– NHL union gains power ==> wages increase ==>
hockey team owners’ cost increases ==> you pay
more for tickets and goods at the stadium
– Natural supply of fish decreases ==> fish prices
increase ==> firms’ costs increase ==> you pay more
at the store for fish
Purchasing Power
• Purchasing power describes the ability to buy
goods and services
• Based on the inflation calculator we looked at
earlier, how has the purchasing power of $1
changed in your lifetime?
Price Index
• A price index is a way to illustrate how a
regular group of goods and services changes
over time.
• The government uses the Consumer Price
Index (CPI) to measure the change in prices of
goods and services over time in our economy.
• They measure a standard set of goods and
services called a market basket to track
changes in prices over time.
Market Basket
• The Bureau of Labor Statistics (BLS) measures
goods and services called the market basket
that most people buy on a monthly basis.
• The BLS measures these prices every month to
track changes.
• What is in the market basket?
Calculating Inflation-Adjusted Prices
Inflation-adjusted price formula:
Year 2 price = Year 1 price x (Year 2 CPI / Year 1 CPI)
Calculating Inflation-Adjusted Prices
Example 1
Let’s go back to the two-liter of Coke that cost
$0.99 in the year you were born (1995). What
would that same bottle of Coke cost you today?
2013 price = 1995 price x (2013 CPI / 1995 CPI)
= $0.99 x (233.0/152.4)
= $1.51
Is this about how much a two-liter of Coke
actually costs today?
Calculating Inflation-Adjusted Prices
Example 2
In 2005, the median income was $46,326. What
would have been an equivalent income in 1960?
1960 price = 2005 price x (1960 CPI / 2005 CPI)
= $46,326 x (29.6/195.3)
= $7,021.25
If the actual median income in 1960 was $5,600,
were people earning more or less relative to the
time period?
Calculating Inflation-Adjusted Prices
Example 3
Let’s compare the median income in 2005 ($46,326)
to today’s median income. What is the inflationadjusted income today (use 2013 information)?
2013 price = 2005 price x (2013 CPI / 2005 CPI)
= $46,326 x (233.0/195.3)
= $55,268.60
If the actual median income in 2013 was $52,100,
are people earning more or less relative to the time
period?
Calculating Inflation-Adjusted Prices
In your groups…
• Assign a manager, writer & calculator
– Manager: get an activity worksheet
– Writer & calculator: move the desks into a pod
• Complete the activity
• When you have a question, “ask 3 before me”