Lecture Notes: Calculating Consumer Price Index (CPI) and Inflation Rate

Introduction

• Focus: Calculating Consumer Price Index (CPI) and Inflation Rate.
• CPI-U: Measure of overall cost of goods for people in urban areas.
• Inflation: Increase in average level of prices in an economy.

Annual Inflation Rate Formula

• Formula:
  • ( \text{Inflation Rate} = \frac{\text{CPI of Current Year} - \text{CPI of Previous Year}}{\text{CPI of Previous Year}} \times 100 )
  • Example: For 2017, ( \frac{\text{CPI 2017} - \text{CPI 2016}}{\text{CPI 2016}} \times 100 ).

Example: Simple Economy

• Goods: Soccer balls, shoes, concert tickets.
• Data for 2016, 2017, and 2018.
• Base Year: 2016.
• Quantities: Needed only for the base year.

Calculating the Consumer Price Index (CPI)

Steps:

1. Calculate Total Cost of Base Year Fixed Basket:

   • Use base year quantities.
   • Example for 2016: Price x Quantity = $5,000 (total cost).

2. Evaluate Fixed Basket Cost for Other Years:

   • Quantities remain constant; prices change.
   • 2017 cost calculation: $5,606.
   • 2018 cost calculation: $6,240.

3. Construct CPI:

   • Formula: ( \text{CPI Year X} = \frac{\text{Cost of Fixed Basket in Year X}}{\text{Base Year Cost}} \times 100 ).
   • 2016: CPI = 100 (base year).
   • 2017: CPI = 113.2.
   • 2018: CPI = 124.8.

Calculating the Inflation Rate

• 2017 Inflation Rate:

  • ( \frac{113.2 - 100}{100} \times 100 = 13.2% ).
  • Prices rose by 13.2%.

• 2018 Inflation Rate:

  • ( \frac{124.8 - 113.2}{113.2} \times 100 = 10.25% ).
  • Prices rose by 10.25%.

Conclusion

• Summary of CPI and Inflation Rate calculations.
• Use of base year costs and fixed basket concept.
• Importance of understanding CPI for economic analysis.