Understanding and Calculating Inflation Rate Using the Consumer Price Index (CPI)
Inflation refers to the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. Central banks attempt to limit inflation, and avoid deflation, with varying price stability targets. A common measure of inflation is the Consumer Price Index (CPI), which tracks the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. If the CPI rises, it indicates that the general level of prices has increased. The inflation rate is then calculated as the percentage change in the CPI from one period to another (typically year-over-year).
How to Calculate Inflation Rate
To calculate the inflation rate between two periods using the CPI, you need the CPI value for the earlier period and the CPI value for the later period. The formula is as follows:
Inflation Rate (%) = [(CPI in Later Period – CPI in Earlier Period) / CPI in Earlier Period] * 100
For instance, if the CPI was 250 in Year 1 and increased to 260 in Year 2, the inflation rate for that year would be:
Inflation Rate = [(260 – 250) / 250] * 100 = (10 / 250) * 100 = 0.04 * 100 = 4%
This means that, on average, prices increased by 4% between Year 1 and Year 2, leading to a decrease in the purchasing power of money.