In this article, we would cover – How do we measure inflation? Inflation is the single-most important variable in the study of economics. Price increases lead to an inflationary environment. Inflation always is a cause of greater concern. Though, we need reasonable inflation to have stable economic growth. But, higher than average inflation affects everyone who is a part of the economy.
Since we are so interconnected with the rest of the world. Inflation, of concern, in one nation, would definitely hamper the growth prospects of other nations as well.
Furthermore, healthy or moderate inflation is good for everyone, it makes prices competitive and ultimately leads to better product discovery by corporations.
We measure inflation using price indexes. CPI (i.e. Consumer Price Index) is one such measure. Through CPI, we get to know the average change in prices of consumer goods and services. In the U.S., the Bureau of Labor Statistics provides monthly CPI data. It is worth mentioning here that, CPI is also used as Cost of Living Index.
Besides, through Consumer expenditure surveys, we get to know which items we need to include in the CPI basket.
How do we calculate CPI?
We need to compare the current year’s prices to that of the base year. We will consider just two goods and assume that the same quantity was consumed in the current and base year. Apart from that, CPI for the base year is 100.
We assume, 2 gallons of gasoline and 2 shirts were used by an average consumer in both the years i.e. 1984 and 2022
Firstly, for 1984 –
| Gasoline | Shirts | |
| Price (1984) | $29.48 | $10 |
| Quantity (1984) | 2 | 2 |
Similarly, for 2022 –
| Gasoline | Shirts | |
| Price (2022) | $102.35 | $21 |
| Quantity (2022) | 2 | 2 |
Now, to calculate CPI for a particular year we divide the market value of total goods and services for the current year by the base year. And, that is the reason why we take the base year as 100.
CPI (1984) = 100* [(2*29.48)+(2*10)/(2*29.48)+(2*10)] = 100
CPI (2022) = 100* [(2*102.35)+(2*21)/(2*29.48)+(2*10)] = 246.7
Next, we need to calculate the inflation rate, which is the percentage change in price level for a specific time period. In this case,
Inflation rate = (246.7-100)/100 = 146.7%
From here, we can say prices have increased by 146.7% when we compare them with our base year 1984.
In conclusion, we have discussed how to measure price increases over a specific time period.
