Many people are confused by the difference between Inflation and the Consumer Price Index. The Consumer Price Index is as its name implies an index, or “a number used to measure change”.
The Consumer Price Index (CPI-U)
The government chose an arbitrary date to be the base year and set that equal to 100. Currently that date is 1984. (Or more accurately the average of the years 1982-1984) previously the base year was 1967 (they change the base year every once in a while so you don’t notice that there has been over 2000% inflation since the start). See Cumulative Inflation Since 1913.
Every month the Bureau of Labor Statistics (BLS) surveys prices around the country for a basket of products and publishes the results as a number. Let us assume for the sake of simplicity that the basket consists of one item and that one item cost $1.00 in 1984. Then the BLS published the index in 1984 at 100. If today that same item costs $1.85 the index would stand at 185.0 of course a group of items would work the same way. If you have 100 items each would account for 1% of the total index.
By itself that does not tell us what the current Inflation rate is. We must do some calculations using that index to tell us the Percentage of increase or decrease in the level of prices.
So How does Inflation or Deflation relate to the CPI?
“Price Inflation” is the percentage increase in the price of the basket of products over a specific period of time.
“Price Deflation” is, of course, the percentage decrease in the price of the basket of products over a specific period of time.
For convenience Price Inflation has been shortened in common usage to simply “Inflation” and similarly Price Deflation has been shortened to “Deflation”.
(*Interestingly this is not Webster’s definition of Inflation… More)
In order to calculate the percent of inflation or deflation we have to use the Consumer Price Index as a starting point.
So assuming You wanted to calculate the inflation rate from July 2000 until July 2008.
You need to know the CPI for the starting and ending dates. So the CPI index in July 2000 is 172.8 and the CPI index is 219.964 in July 2008. (Note they went to a three decimal place accuracy in between).
The formula is: (end -start)/start
so we have (219.964-172.8)/172.8 =
47.164/172.8= .2729
Now that has to be converted to a percent so we multiply it by 100 to get 27.29% inflation.
Normally, the inflation rate is calculated on an annual basis for example from July 2007 until July 2008. That will give you the amount of inflation in one year. Which is typically called “The Inflation Rate“.
So from this example we can see how the Consumer Price Index (CPI) is used to calculate the actual inflation rate.
very good explanation, really helpful, thanks
good explanation