APMacro: Consumer Price Index

The main measure of inflation is the Consumer Price Index (CPI), compiled by the Bureau of Labor Statistics (BLS). The government uses this index to report inflation rates each month and each year. It also uses the CPI to adjust Social Security benefits and income tax brackets for inflation. The CPI reports the price of a market basket of some 300 goods and services that are purchased by a typical urban consumer. The BLS updates the composition of the market basket every 2 years so that it reflects the most recent patterns of consumer purchases and captures the inflation that consumers are currently experiencing. The CPI for any particular year is found as follows:

CPI = (market basket in particular year / market basket in base year) x 100

The rate of inflation for a certain year is found by comparing, in percentage terms, that year’s index with the index in the previous year.

Rate of Inflation = [(index of particular year – index of previous year) / index of previous year] x 100

There is a difference between nominal income and real income. Nominal income is the number of dollars received as wages, rent, interest, or profits. Real income is a measure of the amount of goods and services nominal income can buy. It is the purchasing power of nominal income or income adjusted for inflation.

Real  Income = nominal income / price index (in hundredths)

Real interest rate is the percentage increase in purchasing power that the borrower pays the lender. Nominal interest rate is the percentage increase in money that the borrower pays the lender.

Nominal Interest Rate = real interest rate + inflation rate
Real Interest Rate = nominal interest rate – inflation rate



Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: