USING THE CONSUMER PRICE INDEX (CPI)
Inflation is a decline in the purchasing power of money, meaning that prices are increasing. For
budgeting, inflation either drives spending up or services down because it takes more dollars to
purchase supplies and equipment and to provide services. More dollars are needed to continue
doing what has been done in the past.
The best-known gauge of changing prices is the Consumer Price Index (CPI). This measures the
average change in the prices of consumer items, the goods and services that people buy for daily
living. The U.S. Department of Labor, Bureau of Labor Statistics (BLS) compiles the CPI. The
CPI for All Urban Consumers (CPI-U) covers approximately 87 percent of the population.
The CPI-U is important economically, and also politically. According to the U.S. Department of
Labor, Bureau of Labor Statistics (BLS, http://www.bls.gov/cpi/cpiovrvw.htm#item4):
Over 2 million workers are covered by collective bargaining agreements which tie
wages to the CPI. The index affects the income of almost 80 million people as a result
of statutory action: 47.8 million Social Security beneficiaries, about 4.1 million military
and Federal Civil Service retirees and survivors, and about 22.4 million food stamp
recipients. Changes in the CPI also affect the cost of lunches for the 26.7 million
children who eat lunch at school. Some private firms and individuals use the CPI to
keep rents, royalties, alimony payments and child support payments in line with
changing prices. Since 1985, the CPI has been used to adjust the Federal income tax
structure to prevent inflation-induced increases in taxes.
The CPI takes inflation into account or controls for inflation by converting current dollars into
constant dollars (see figure 1). Current dollars refers to the dollar's purchasing power today.
Constant dollars are the number of dollars it would take to purchase the same goods and services
(or market basket in a chosen base year). The BLS data uses 1982-1984 as the base year for
calculating the CPI-U. A CPI-U of 220 in 2008 indicates 120 percent inflation since 1982. The
BLA inflation calculator informs us that it takes almost $2,222 in 2008 to match the purchasing
power of $100 in 1913. The rate of inflation--say, 3 or 4 percent--is the change in the CPI-U
from the previous year.
Step One. What is a car's cost in constant dollars?
1. Divide the current CPI-U by 100
2. Divide the current cost by the result from #1
3. Divide the base-year CPI-U by 100
4. Multiply the result from #2 by the result from #3 which will tell you what the current cost
is in constant dollars (dollars adjusted for inflation)
[Alternative: use BLS inflation calculator]
Let us say that you bought a car for $23,885 in 2007, but you bought one for $13,542 a decade
earlier. Was the more recent purchase really more expensive? After all, salaries have increased,
along with the housing and other costs, and a dollar simply ain't what it used to be. How much
did the new car really cost in 2007, compared to the one you bought a decade earlier?
To find out, we compare the car's cost in constant dollars over the ten years, starting with 1997
as the base year. We need to know (1) the cost of the car in 2007, $23,885, (2) the CPI-U for
2007, 207.8, (3) the car's price in 1997, $13,542, and (4) 1997 or base-year CPI-U, 159.4 (using
data extracted August 12, 2007). Simple arithmetic comes next:
1. (207.8) / (100) = 2.078
2. ($23,885) / (2.078) = $11,494
3. (159.4) / (100) = 1.594
4. ($11,494) x (1.594) = $18,321
The car is more expensive in real terms (or constant dollars): $18,321 versus $11,494.
Step Two. How much of a spending increase is due to inflation?
We also can figure out what portion of the increase in the number of dollars (nominal increase) is
due to inflation by calculating the constant dollar increase as a percentage of the original price.
1. (2007 cost in constant dollars) - (1997 price) =
cost increase in real terms (increase in constant dollars)
($18,321) - ($11,494) = $6,827
2. (Constants dollar increase) / (1997 price) = percent of increase due to inflation
($6,827) / ($13,542) = 0.50 or 50% of the increase is due to inflation
We now know that 50% of the increase is due to inflation. This demonstrates a real increase in
How useful is the CPI for looking at government spending?
Because governments do not buy consumers' market baskets, the CPI-U is not suitable for
scrupulous analysis of government spending. (Another problem is that price indexes are figured
on calendar years, but governments spend on fiscal years.) The BLS recommends that we choose
the index that best reflects the costs relating to a specific product or service, and professional
best practice is shown in the table 1.
Table 1. Implicit Price Deflator for Gross Domestic Product
Government consumption expenditures
And gross investment 86.00 114.72
Federal 87.04 115.25
Non-defense 86.31 113.96
State and local 85.48 114.42
How to calculate the CPI and inflation rate?It is easy to use this CPI inflation calculator all you need to do is the following:Select a start date and input the year and the month you want the calculator to run the calculations from.Select an end date and input the year and month you want the calculator to end the calculations on.Enter the initial amount you wish to be adjusted by CPI index change for your chosen period.More items...
Title: Application: Using the Consumer Price Index (CPI)
Author: Carol Lewis
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