In the previous article, we briefly touched on Inflation rate calculation. It was mostly about CPI. That’s why we thought of writing this article. Here, we would discuss how we can calculate the inflation rate.
The inflation rate is the percentage change in the price level over a specific time period. Along with CPI, it is a good measure to gauge the effectiveness of Government policy. Furthermore, we need to first identify the price index which we will use to calculate the inflation rate.
The price index could be one of the following –
- GDP deflator,
- CPI,
- PCE deflator.
Since we haven’t covered the GDP deflator and PCE deflator yet. Therefore, we would illustrate the inflation rate through CPI. CPI stands for Consumer Price Index. It is the average change in prices of consumer goods and services. Follow the article to measure inflation if you want to know more.
How do we calculate the Inflation Rate?
We need to first find the difference between the price level of a base year and the current year. Thereafter, divide the result by the base year price level. This is how it looks –
Inflation rate = (Pcurrent – Pbase) / Pbase
Let’s understand it with the help of an example. Assume that CPI for the current year is 104 and we do calculations over a five-year period. So, the base year, in this case, would be 2017. We always use the Price level as 100 for the base year.
Therefore, the inflation rate would be –
Inflation rate = (104 – 100) / 100 = 4 %
From here, we can say over a five-year period inflation rate was 4%.
It is worth mentioning here that, we calculate the inflation rate with a simple mathematical formula. Although, its usefulness can’t be denied. But, we just want to add here that, different price indexes would yield different results. So, the inflation rate could be different for different price indexes. But, one thing is for sure – despite the differences if there is a change in price level it would show up in the data anyway.
In conclusion, with the inflation rate, we can calculate how the price level in different years changes over a base year.
