2.4 Index Numbers

LEARNING GOAL Understand the concept of an index number; in particular, understand how the Consumer Price Index (CPI) is used to measure inflation.

Thought Question 1

Bob drives a Honda Accord LX. When he bought it in 1986, it cost about $11,500. A comparable new Honda Accord LX today costs about $21,000. How has the price of a Honda Accord LX changed from 1986 to today?

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Thought Question 2

In the school year 1978-79 the beginning teacher salary for Cape Public Schools was $9250. In the 2009-10 school year a beginning teacher makes $29,463. Do beginning teachers have more buying power today?

What information do we need to know?

Consumer Price Index 3

Index Numbers

An index number provides a simple way to compare measurements made at different times or in different places.

Index number=(value)/(reference value) X 100

Average Gasoline Prices

Year

1955

Price

$.29

• What is the price index for 2005 with the price in 1975 as the reference value?

1965 $.31

1975 1985 1995 $.57

$1.20

$1.21

• What is the price index for 1955 with the price in 1975 as the reference value?

2000 2005 2008 $1.55

$2.31

$3.27

• What is the price index for 2008 with the price in 2000 as the reference value?

• Suppose that it costs me $25 in 2000 to fill my gas tank, how much did it cost in 2008 to fill the same tank?

•

Inflation

: the phenomenon of prices and wages rising over time • What are some examples of inflation?

•

Deflation

: the phenomenon of prices and wages declining over time • What are some example of inflation?

Fixed Market Basket Price Index

• An index number for the total cost of a fixed (constant) collection of goods and services.

• The Consumer Price Index (CPI) is a fixed market basket price index used to judge inflation ▫ has several hundred items that represent all consumer purchases 7

Consumer Price Index (CPI)

▫ CPI is a measure of the average change in prices over time of goods and services purchased by households.

▫ It tracks the buying power of the dollar over time. A dollar in 2010 buys less than a dollar in 1990.

▫ The Consumer Price Index (CPI) helps us plan for the future.

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Consumer Price Index

▫ We can find index number for different important consumer purchases.

▫ CPI is the index number for the cost of everything that consumers buy.

▫ The CPI is based on the process of food, clothing, shelter, and fuels, transportation fares, charges for doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. ▫ Prices are collected in 87 urban areas across the country from about 50,000 housing units and approximately 23,000 retail establishments department stores, supermarkets, hospitals, filling stations, and other types of stores and service establishments.

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Consumer Price Index

Prices of fuels and few other items are obtained every month in all 87 locations.

10 ▫ ▫ ▫ Prices of most other commodities and services are collected every month in the three largest geographic areas and every other month in other areas.

The Bureau of Labor Statistics publishes CPIs for two population groups: CPI-W: CPI for urban wage earners and clerical workers; comprises approximately 32% of the population.

CPI-U: CPI for all urban consumers; comprises approximately 87% of the population. It also includes professional, managerial, technical workers, self employed, short term workers, unemployed and retirees.

Consumer Price Index

The index is calculated by averaging the price changes for various items in each location with weights, which represent their importance in the spending of the appropriate group.

The index measures the price change from a base period. For both CPI-W and CPI-U, the base period is 1982-84.

The CPI for the base period 1982-84 is 100.

The CPI for December 2010 was 219.179. It means that there has been an increase of 119.179% from the base period. It can also be explained as follows: the consumer commodities which used to cost $100 in 1982-84 now cost $215.949.

http://www.bls.gov/cpi/home.htm

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Consumer Price Index

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•In 1980 Indiana residents at Purdue University paid $1158 in tuition. In 1999 the tuition was $3624. •Calculate the percentage rise in cost from 1980 to 1999.

•Compare the percentage rise to the overall rate of inflation as measured by the CPI.

Using the CPI

To convert an amount in dollars at time A to the amount with the same buying power at time B, use the following formula: Dollars at time B = (Dollars at time A) x

(

CPI at Time B / CPI at Time A

)

Thought Question 2: Answer

• In the school year 1978-79 the beginning teacher salary for Cape Public Schools was $9250. In the 2009-10 school year a beginning teacher makes $29,463. • Convert the 1978-79 salary to 2009-10 dollars.

• Do beginning teachers today in Cape Public Schools have more buying power?

CPI: Example ▫    The median salary in the United States in 1980 was $17,710. The median salary in 1999 was $40,816.

Find the absolute increase in salary.

Find the dollar value in 1999 which will have the same buying power as $17,710 had in 1980.

Find the real increase.

▫ ▫ ▫  For the top 5% of the population, the median salary in 1980 was $51000 and in 1999 median salary was $142,021.

For working class, average hourly income in 1980 $ 6.60 and in 1999 it was $13.28.

Answer the above questions again.

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Tuition at Southeast Missouri State

• • • For the 1974-75 school year, the tuition for a full time student was $110/semester.

For the 2009-10 school year, the tuition is $184.80/ credit hour. 15 credit hours carries a fee of $2760.

Convert the 1974 tuition to the 2009 dollars.

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