Economics: How is inflation calculated?

[busydude]

I understand the basic formula for calculating the inflation rate, but how does one select the parameters which accurately estimate inflation rate?

 

[D1gger]

The formula for calculating the Inflation Rate using the Consumer Price Index is relatively simple. Every month the Bureau of Labor Statistics (BLS) surveys prices and generates the current Consumer Price Index (CPI). Let us assume for the sake of simplicity that the index consists of one item and that one item cost $1.00 in 1984. The BLS published the index in 1984 at 100. If today that same item costs $1.85 the index would stand at 185.0
By looking at the above example, common sense would tell us that the index increased (it went from 100 to 185). The question is how much has it increased? To calculate the change we would take the second number (185) and subtract the first number (100). The result would be 85. So we know that since 1984 prices increased (Inflated) by 85 points.

http://www.inflationdata.com/inflation/Inflation_Articles/CalculateInflation.asp

 

[AyashiKaibutsu]

It's calculated in a way that makes whoever is calculating it right about what they're talking about (Kind of like unemployment).

 

[JulesMaximus]

You take a bunch of items that people buy all the time and then you offset the cost increases on those with items that people rarely buy and arrive at a completely arbitrary figure that has zero basis in reality and call it the inflation rate.

 

[busydude]

It says BLS surveys prices and generates CPI. Prices of what? I tried looking for that, but I got no info on it.

 

[PingSpike]

Rand()*0.5

 

[busydude]

You take a bunch of items that people buy all the time and then you offset the cost increases on those with items that people rarely buy and arrive at a completely arbitrary figure that has zero basis in reality and call it the inflation rate.

Yeah, that is one of concerns here. One size fits all does not work.. I know it is logistically impossible to tailor that to individual's needs, but is inflation calculated separately for each city/state? Because.. a single model for an agricultural state and an predominantly urban state sounds a bit silly.

 

[busydude]

Also, when was the last time US updated/revised the list of things that are to be included in calculating inflation?

 

[ElFenix]

Also, when was the last time US updated/revised the list of things that are to be included in calculating inflation?

http://www.bls.gov/cpi/cpifaq.htm#Question_6

Yeah, that is one of concerns here. One size fits all does not work.. I know it is logistically impossible to tailor that to individual's needs, but is inflation calculated separately for each city/state? Because.. a single model for an agricultural state and an predominantly urban state sounds a bit silly.

http://www.bls.gov/cpi/cpifaq.htm#Question_17

the fact of the matter is that so few people live in non-urban areas that a rural cpi would tell us not much.

 

[dullard]

Yeah, that is one of concerns here. One size fits all does not work.. I know it is logistically impossible to tailor that to individual's needs, but is inflation calculated separately for each city/state? Because.. a single model for an agricultural state and an predominantly urban state sounds a bit silly.

Detailed information is listed on the BLS website. Click here!

For example, it assumes the typical person spends 1.09% of their money on cereals and bakery products. Who spends exactly that amount? Probably very few people. But, it does give a general idea of what the average person might see as a price increase. It is obtained from surveys of buying habits (done every few years).

Notice on that table that they have CPI-U and CPI-W with different percents. The U stands for all Urban consumers (87% of the population). The W stands for Wage Earners and Clerical urban workers (generally lower income consumers). Lower wage people buy different items than higher salaried people.

Now scroll down to table 2 (begins on page 6). There they break it down for different metropolitian locations: Boston vs Cincinnati vs Cleveland etc for dozens of cities. It is also broken down for areas (midwest vs south vs west vs northeast).

As far as I know they don't go into rural areas since most people aren't rural and since it is really hard to give a typical expense. One rural customer might drive 2 hours to the grocery store (each way) while another rural customer might just grow his/her own food.

The national media normally reports the national average CPI-U.

Edit: ElFenix beat me to some of this.

 

[dullard]

There is now also a chained CPI. Chained CPI means you assume customers switch to lower priced items if one item skyrockets in price. For example, if nectarines go up in price, the customer might buy oranges instead. This is probably more realistic, but it is politically a nightmare (just look at the pesimistic people in this thread already).

 

[JulesMaximus]

There is now also a chained CPI. Chained CPI means you assume customers switch to lower priced items if one item skyrockets in price. For example, if nectarines go up in price, the customer might buy oranges instead. This is probably more realistic, but it is politically a nightmare (just look at the pesimistic people in this thread already).

What do people substitute when the price of gasoline goes up?

 

[busydude]

the fact of the matter is that so few people live in non-urban areas that a rural cpi would tell us not much.

The U stands for all Urban consumers (87% of the population). The W stands for Wage Earners and Clerical urban workers (generally lower income consumers). Lower wage people buy different items than higher salaried people.

I honestly did not know 87% of the population live in urban areas.. I though I was more like 70-30 split.

Thanks dullard and Elfenix.. those charts are mighty helpful. Could be of interesting use like comparing spending habits from different countries.

 

[ElFenix]

What do people substitute when the price of gasoline goes up?

over time spending patterns change - mass transit, carpooling, smaller cars, etc. an inflation measure should account for that rather than just assuming 100 gallons a month now and forever. for a similar size car the more efficient one is generally going to cost more to make and cost more to the end consumer, so partly gas savings are offset by increased car prices.

 

[GotIssues]

What do people substitute when the price of gasoline goes up?

The bus, a bike, carpooling, more efficient car, walking. Probably a few more I didn't think of off the top of my head.

Given a sufficient price increase, nearly everyone would switch to an alternate. It's one of the reasons that OPEC should be worried about higher gas prices - higher gas prices means more pressure to develop alternatives.