Ways to Measure Inflation

Common indices to measure inflation include the Consumer Price Index (CPI), the Producer Price Index (PPI), and the GDP Price Deflator.

The Consumer Price Index (CPI)

The most common measure of inflation is the CPI, or Consumer Price Index. This figure is a weighted average of price increases of a typical basket of consumer products. The term “weighted” means that price increases of products that are bought in large quantities increase the CPI more than products that are not consumed as commonly. If the price of a commonly purchased product, such as a movie theater ticket, increases, it will have a greater impact on the CPI than if the price of an infrequently purchased product, such as a bag of salt, increases.

The CPI also takes into account the price of the product. For example, a 10% increase in the price of a car affects buyers more than a 10% increase in the price of a pack of bubblegum.

Government accountants at the Bureau of Labor Statistics include the following categories in the representative “market basket” of consumer products for CPI calculation purposes: housing (41%), transportation (17%), food and beverages (16%), medical care (6%), recreation (6%), apparel (4%), and other (4%).

Please click HERE  (then click on CPI tables) for a link to a web page from the Bureau of Labor Statistics. This link contains information on CPI changes from 1913 until the present. Let’s say that, for example, we want to calculate inflation between January  of 1985 and January of 1986. We notice from the table that the CPI index number for January of 1985 is 105.5. The CPI for January of 1986 is 109.6. To calculate the consumer price inflation rate between these two dates, we take

 The difference in the index values/ the index value of the first year In the above example: (109.6 minus 105.5) / 105.5 = 4.1 / 105.5 = .0388 or 3.89%.

Another way to find inflation rates between various years is to Internet search for “inflation calculator” and insert the appropriate years in the boxes. For example, you can find an excellent one at http://data.bls.gov/cgi-bin/cpicalc.pl. Using this site, we notice that \$100 in January of 1975 has about the same purchasing power as \$600 today. In other words, prices on average are almost 6 times higher since 1975 in the United States.

The Producer Price Index

The Producer Price Index (PPI) is also a weighted index. It measures price changes of intermediate and final products that businesses buy.

Please click HERE (then click on PPI tables) for a link to a Bureau of Labor Statistics web page with information and data on the PPI. The BLS site also contains information about what is included in the PPI, how it is calculated, and time series data. Click HERE for the latest PPI changes.

The GDP Price Deflator

The GDP deflator measures price changes of all final goods and services. It is defined as nominal GDP divided by real GDP. For example, if nominal GDP is \$10,000, and real GDP is \$9,500, then the GDP price deflator is \$10,000 divided by \$9,500, or 1.05.

 GDP deflator = nominal GDP / real GDP In the above example: GDP deflator = \$10,000 / \$9,500 = 1.05
A GDP deflator of 1.05 means that prices of all final goods and services during this year increased by .05 (1.05 minus 1). Expressed as a percentage increase, we multiply the decimal by 100 and obtain a GDP deflator value of 5% (100 times .05).
Problems with Inflation Measures

Calculating the numbers for the various inflation measures is not an exact science. The CPI and the PPI are based on a fixed basket of goods and services. But how do you compare a price increase of a product that did not exist several years ago? Driverless cars and drones are relatively recent innovations. Furthermore, how do you evaluate a product’s price increase if the quality of the product has changed? Today’s smart phones are different and can do much more than phones from a decade ago.

As prices change, buyers’ quantities purchased change. When gasoline prices increase, buyers may change to more fuel efficient cars (smaller cars, or hybrids, or electric cars) or public transportation. The index in the latter year will be overstated if the quantities purchased (in the basket to compute the index) from a previous year are used.

In August, 2002, the United States government started using the Chained Consumer Price Index. This index corrects for these consumer adjustments. You can find a link at https://www.bls.gov/cpi/additional-resources/chained-cpi.htm.