8.2 – Tracking Inflation
Learning Objectives
By the end of this section, you will be able to:
- Calculate the annual rate of inflation
- Explain and use index numbers and base years when simplifying the total quantity spent over a year for products
- Calculate inflation rates using index numbers
Dinner table conversations where you might have heard about inflation usually entail reminiscing about when “everything seemed to cost so much less. You used to be able to buy three gallons of gasoline for a dollar and then go see an afternoon movie for another dollar.” Table 1 compares some prices of common goods in 1980 and 2022. Of course, the average prices in this table may not reflect the prices where you live. The cost of living in New York City is much higher than in Houston, Texas, for example. In addition, certain products have evolved over recent decades. A new car in 2023, loaded with antipollution equipment, safety gear, computerized engine controls, and many other technological advances, is a more advanced machine (and more fuel efficient) than your typical 1980s car. However, put details like these to one side for the moment, and look at the overall pattern. The primary reason behind the price rises in Table 1—and all the price increases for the other products in the economy—is not specific to the market for housing or cars or gasoline or movie tickets. Instead, it is part of a general rise in the level of all prices. At the beginning of 2022, $1 had about the same purchasing power in overall terms of goods and services as 28 cents did in 1980, because of the amount of inflation that has occurred over that time period.
| Items | 1980 | 2022 | % Change |
|---|---|---|---|
| Pound of bacon | $1.45 | $7.30 | 403% |
| Dozen eggs | $0.88 | $2.86 | 225% |
| KWH of electricity | $0.05 | $0.16 | 220% |
| Sales price of new home (median) | $64,708 | $455,850 | 524% |
| Gallon of gasoline | $1.13 | $3.80 | 236% |
| Average hourly wage for nonmanagerial workers | $6.85 | $27.56 | 302% |
| Per capita GDP | $12,547 | $77,172 | 515% |
| (Sources: Federal Reserve Economic Data) |
Moreover, the power of inflation does not affect just goods and services, but wages and income levels, too. The second-to-last row of Table 1 shows that the average hourly wage for a nonmanagerial worker in the goods-producing sector increased about four-fold from 1980 to 2022. Per capita GDP increased substantially from 1980 to 2022, but is the average person in the U.S. economy really more than six times better off in just 42 years? Not likely.
A modern economy has millions of goods and services whose prices are continually changing. How can all of these shifts in price attribute to a single inflation rate? As with many problems in economic measurement, the conceptual answer is reasonably straightforward: Economists combine prices of a variety of goods and services into a single price level. The inflation rate is simply the percentage change in the price level. Applying the con