Your mom says she made $25,000 in 1981. You say, “Big deal.” She says that was a lot of money back then. Do you believe her? CPI Consumer Price Index Consumer Price Index The Consumer Price Index (CPI) is a measure of the general change in prices over a given amount of time. Components of the CPI Housing 41.4% Transportation 17.8% Food 16.2% Energy 8.2% Medical Care 6.4% Apparel and Upkeep 6.1% Other 3.9% Inflation Calculate inflation from 2005 to 2006 New - Old % inflation Old You calculate inflation from 1929 to 1930 We found that the inflation rate from 2005 to 2006 was 3%. If your boss in 2005 said that over the next year you were going to get a 2% raise would that make you smile? Why or why not? Ratio of Prices Ratio of two indices 2006 to 2005 CPI 2006 201.6 1.03 CPI 2005 195.3 On average consumer goods of 2006 cost 1.03 times that of 2005. Ratio of Prices Ratio of two indices 2010 to 1981 CPI 2010 218.1 2.4 CPI1981 90.9 On average consumer goods of 2010 cost 2.4 times that of 1981. So if your mom was making $25,000 in 1981, she would equivalently need to be making: 2.4*25,000 = $60,000 in 2010 to account for inflation Converting to Constant Dollars NewCPI new constant dollar price or salary OldCPI old price or salary NewCPI *(old price or salary) new constant dollar price or salary OldCPI CPI We can use the CPI to adjust prices (constant dollars) so that we can accurately compare them. Actual Dollars = an absolute dollar value Constant Dollars = dollars that have been adjusted to reflect inflation Converting to Constant Dollars In 1930 Babe Ruth made $80,000 per year. Alex Rodriguez currently makes $32 million. In terms of actual dollars Rodriguez is making a lot more. But in terms of constant dollars did Ruth make more or less than Rodriguez? Converting to Constant Dollars Find the CPI values for your two years (2010 and 1930) and convert Babe’s salary to 2010 constant dollars NewCPI *old salary new constant dollar salary OldCPI 2010CPI *1930Salary 2010 Constant Dollar Salary 1930CPI 218.1 *$80, 000 $1, 044, 790 16.7 But in terms of constant dollars did Ruth make more or less than Rodriguez? $1,044,790 $32,000,000 “Expensive” You can check to see if some good increased in price at the same rate as the CPI or at a slower or faster rate. For example, the price of gasoline in 1981 was $1.38 per gallon on average. In 2005, it averaged $2.30. Was gasoline more expensive or less expensive in 2005? “Expensive” Need to take inflation into consideration. Convert the 1981 price to 2005 constant dollars. 2005CPI *1981Price 2005 Constant Dollar Price 1981CPI 195.3 * $1.38 $2.96 $2.96 $2.30 90.9 “Expensive” Since $2.96 is more than the $2.30 that people were actually paying in 2005, gasoline was more expensive in 1981 than it was in 2005 after we account for inflation using constant dollars. Put another way, the $1.38 you were spending in 1981 was affecting you more than the $2.30 you are spending in 2005.
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