[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

To see how a price index like the CPI is constructed, we can calculate one for
Bob, who spends all his income on rent, Big Macs, and CDs. Let’s suppose his total
expenditures during 2003 were $1,500 each month, of which $1,000 went for rent,
$200 for 100 Big Macs (which cost $2 each), and $300 for 15 CDs (which cost $20
each). In 2004, his rent increases to $1,200 and Big Macs go up in price to $2.25,
while the price of a CD falls to $18. What has happened to Bob’s price index? We
want to know how much it costs, in year 2004, to buy the same basket of goods Bob
purchased in 2003. In 2003, these goods cost $1,500. In 2004, they cost $1,695: $1,200
for rent, $225 for 100 Big Macs, and $270 for 15 CDs. Bob’s cost of living has increased.
Setting the value of the index equal to 100 in the base year of 2003, Bob’s price index
in 2004 will equal 100 × 1,695/1,500 = 113.
The inflation rate is the percentage change in the price index. So if we look at Bob’s
price index, it rose from 100 to 113 between 2003 and 2004, an increase of 13 percent.
Inflation as measured by his price index was 13 percent in 2004. Now let’s look at the
actual CPI for the United States. The CPI in 2003 was 184.0; that is, the general level
of consumer prices was 84.0 percent higher than it had been in the base years of
1982–1984. In 2004, the index rose to 187.6. The inflation rate in 2004 was the percentage
change in the CPI from 2003 to 2004, or 100 × (187.6 − 184.0)/184.0 = 1.96 percent.
Summarizing the movements of masses of prices into a single index provides
an easy way to look at price trends over time. The advantages of an index are that
once an index number is calculated for a given year, we can compare it with any
other year. For example, the CPI for 1973 was 44.4, and for 2002 it was 179.9. Between
those years, the index rose by 135.5, so the increase was
100 × 135.5/44.4 = 305 percent.
200
180
160
CPI (1982–1984 = 100)
140
120
100
80
60
40
20
0
1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
Figure 23.2
THE CONSUMER PRICE INDEX
FOR 1913 TO 2003
Consumer prices have risen significantly since the early years of the twentieth century,
with most of the increases occurring since 1970.
SOURCE: Bureau of Labor Statistics.
MEASURING INFLATION ∂ 515