Transcript Slide 1

LSP 120: Quantitative Reasoning and
Technological Literacy
Topic 8: Consumer Price Index & Inflation
Prepared by Ozlem Elgun
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Inflation
• Detailed CPI tutorial
• Inflation is a decline in the value of money in relation to the goods
that it can buy and is a pervasive economic phenomenon. It is so
pervasive that it is very difficult to compare this year’s prices to last
year’s, much less compare prices over decades. Here is a graph of the
buying power of $1.00 since 1938:
Prepared by Ozlem Elgun
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The Consumer Price Index (CPI)
• Since we have to deal with the inflation factor, how is the "buying power" of
$1.00 measured? Given inflation how can we compare prices of an item or
items in different years?
• Having established empirically that the value of money changes, the next
question is, why should we care? There are many reasons, but the probably
the most important reason is that we need to make sure that our wage
increases are roughly in line with inflation. If wages are increasing more
slowly than prices, then people's incomes are decreasing even though their
wages are increasing nominally.
• It was precisely these concerns that led the United States Bureau of Labor
Statistics to start publishing the CPI in 1917. Inflation was very high during
World War I, and there was considerable labor strife. It was thought that if
there was an official inflation rate sanctioned by a neutral third party, it
might assist in the negotiation of labor contracts and perhaps even help
prevent strikes.
• the consumer price index (CPI)Prepared
allows
us to compare prices of an item in3
by Ozlem Elgun
different years
CPI
• Below is a simplified explanation of how the indices are created and how we can
use them. [for a detailed explanation see Detailed CPI Tutorial on the class website
under Topic 7] Economists choose a base year and determine the price of a
"bundle" of goods: food, clothing, housing costs, transportation costs, services,
entertainment in varying proportions. The proportions for the index we are using
(CPI(U)) are:
Components of the CPI(U)
Housing
41.4%
Transportation
17.8%
Food
16.2%
Energy
8.2%
Medical Care
6.4%
Apparel and
Upkeep
6.1%
Other
3.9%
• The cost of this bundle in one year is assigned an index number. The next year, the
cost of the same bundle is determined. The CPI for that year represents the new
cost of the bundle.
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Using the Consumer Price Index
The table below shows the official CPI since 1990. We will
explore how it is used.
How can you interpret the table?
The beauty of this table is that we can
easily compare any two years prices.
For example, from the table we can see
that in 1990, it would cost $130.70 for
goods and services costing $201.60 in
2006.
But also from the table we can see that in
1995, it would cost $152.40 for goods and
services costing $201.60 in 2006.
We can therefore say that $130.70 in 1990
is equivalent to $152.40 in 1995 which is
equivalent to $201.60 in 2006.
Prepared by Ozlem Elgun
Year
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
CPI
1982 through 84=100
130.7
136.2
140.3
144.5
148.2
152.4
156.9
160.5
163.0
166.6
172.2
177.1
179.9
184.0
188.9
195.3 5
201.6
A relationship between the factors...
• This information will allow us to calculate how many times
more the prices of goods were in one year than in
another. Using 1995 and 2006 as an example, we can
calculate the ratio of the CPI values for those two years:
• This means that ratio of the CPI values of 2006 to 1995 is
1.32. This means that something that costs 1 dollar in 1995,
11 years later, in 2006 costs $1.32.
• The CPI allows you to convert anything money related (prices,
wages, salaries) from one year to another.
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Comparing amounts from two different years
(converting to Constant Dollars "by hand")
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Example 1: Let's say your boss said she made $18,000 a
year at her first job out of college in 1988. That doesn't
sound like a lot of money to us today, but we must consider
that everything was less expensive in 1988. What is that
salary worth in 2006? To answer that, we can convert the
$18,000 to 2006 constant dollars using the CPI values for
those years (found in CPI.xls on class website).
The CPI table tells us that 118.3 in 1988 dollars is equivalent
to 201.6 in 2006 dollars.
We wish to know: $18,000 in 1988 dollars is equivalent to
how much money in 2006 dollars.
This ratio tells us that one dollar in 1988 is equivalent to
$1.70 in 2006. Another way to think about it is that prices
were, on average, 1.7 times more in 2006 than in 1988.
Multiplying the wage of $18,000 by this ratio completes the
conversion: 18,000 * 1.7 = $30,600
This means that your boss’ $18,000 salary in 1988 is
equivalent to making $30,600 a year in 2006.
Prepared by Ozlem Elgun
Year
CPI
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
118.3
124.0
130.7
136.2
140.3
144.5
148.2
152.4
156.9
160.5
163.0
166.6
172.2
177.1
179.9
184.0
188.9
195.3
201.6
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This interpretation of the CPI also allows us to compare prices in two different years and
determine when an item was more expensive. We can calculate whether an item increased in
price at the same rate as the "bundle of goods" or at a faster or slower rate.
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Example 2: 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?
On the face of it, it seems that gas is more expensive in
2005. Using the CPI values (found in CPI.xls):
What this tells us is that $1.38 in 1981 was equivalent to
$2.96 in 2005.
$2.96 is the 1981 price in constant 2005 dollars.
In other words, when Americans paid $1.38 per gallon for
gasoline in 1981, it was equivalent to paying $2.86 in 2005.
We can now compare the actual price in 2005 to the 1981
price in constant 2005 dollars. 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.
Prepared by Ozlem Elgun
Year
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
CPI
90.9
96.5
99.6
103.9
107.6
109.6
113.6
118.3
124.0
130.7
136.2
140.3
144.5
148.2
152.4
156.9
160.5
163.0
166.6
172.2
177.1
179.9
184.0
188.9
195.3
201.6
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Let’s see the current gasolune
price/gallon
• You need two things
• http://fuelgaugereport.aaa.com/?redirectto=h
ttp://fuelgaugereport.opisnet.com/index.asp
• http://bls.gov/
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Using the F4 Key:
•
As part of activity 11, we learn using the (F4) key or "freezing" the
value. By touching the (F4) key after entering a cell reference, a
dollar sign is placed before the letter and number. (If you touch the
F4 key more than once, it toggles the dollar signs and allows for
mixed references.) Using the F4 key is essentially the same as
typing in the number but it goes against my motto that "if you see a
number you should click on". This shows students how to create
absolute references in Excel (as compared to relative references.
• The tutorial below shows you how to create CPI ratios in Excel to
find the constant dollar value of a price/wage, using absolute cell
references (Using the F4 key)
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Absolute Cell References:
How to find the CPI Ratio in Excel in order to calculate constant dollar value of a price/wage/salary
Below example: CPI ratio for calculating 2010 constant dollars
Prepared by Ozlem Elgun
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Absolute cell references:
How to find the CPI Ratio in Excel in order to calculate constant dollar value of a price/wage/salary
Below example: CPI ratio for calculating 2010 constant dollars
Prepared by Ozlem Elgun
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Final Project
• If you have prices listed in your tables that are
not adjusted for inflation, then you will need
to use CPI.xls to make sure that the prices are
adjusted for inflation. Otherwise you cannot
make a graph and effectively compare prices
across years.
Prepared by Ozlem Elgun
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Creating an absolute cell reference on
Mac Computers
• The F4 key does not have the same function
on Macs.
• In order to freeze the cell value as it is
explained above, on a Mac computer you
need to actually type the $ signs before and
after the Column letter of the cell reference.
• So in our example above you need to type:
=$B$110/B12, hit enter and drag it down.
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