Table of Contents:
- What is inflation rate?
- Consumer Price Index (CPI) considerations
- Inflation rate formula, explained
- How to calculate the inflation rate over a period of time
- Other methods of calculating inflation rate
- Inflation rate FAQs
- The bottom line
Inflation may be something wed all like to avoid, especially when it starts interfering with our everyday purchases and the cost of living. The rise in gas prices, utilities, groceries, and more are all things that are constant in our day-to-day lives. When prices go up, it affects people’s ability to purchase the same quantity of items at the same price. This is called purchasing power. The more prices increase, the weaker the purchasing power, and when prices decrease, the more purchasing power you have.
Understanding what inflation means, how it affects us, the inflation rate formula and how to find the inflation rate are important factors that contribute to navigating rising costs in an economy.
Key Takeaways:
- Inflation is the rate at which prices increase for goods and services over a period of time.
- The inflation rate is the measure of inflation expressed as a percentage.
- Inflation formula: To understand how to calculate inflation, you will need to determine the specific good or service you would like to calculate the inflation rate for and the specific years that you would like to calculate. The average costs for goods and services can be found in the Consumer Price Index (CPI) average price data.
- Other methods that you can use to find the inflation rate include using a base year.
What is inflation rate?
Inflation is the rate at which prices increase for goods and services over a period of time. The inflation rate is the measure of inflation expressed as a percentage. Inflation has a domino effect in that when the rate of inflation increases, it affects people’s purchasing power in the economy and the overall health of businesses. When prices rise, businesses may grapple with sustainability because of consumers inability to purchase at the same frequency. However, when the inflation rate is at a steady pace or prices drop at a moderate rate, it could result in more profit for businesses due to consumers being able to spend more.
Deflation, which is the opposite of inflation, is when the price of goods and services decreases over a period of time. Similar to inflation, deflation may be good or bad depending on whether youre a consumer, a business, or what position you have in an economy. The rate at which prices decrease in an economy can also result in a higher rate of unemployment.
Lets say a cup of coffee costs $3.50. For $10.00, youll be able to purchase two cups of coffee. However, if you choose to save your money, and prices increase for a single cup by $2.00 (to $5.50), you would now only be able to purchase one cup of coffee if you only had $10.00. The rate of inflation heavily impacts consumers’ purchasing power and the cost of living, which affects the overall progression of an economy. Lets move on to the inflation rate formula and how understanding price volatility can help you navigate your finances.
Consumer Price Index (CPI) considerations
When calculating the inflation rate formula, the CPI is instrumental in finding out how the costs of goods and services have changed. The CPI measures the average change in costs of a market basket of goods and services purchased by consumers over time. The goods and services the CPI measures range from foods like coffee, milk, and cereal to housing costs, transportation, medical expenses, clothing, household furnishings, airline fares, and more. The Bureau of Labor Statistics (BLS) records and reports the prices per item for these goods and services every month. The CPI is used to not only show the changes in costs of goods and services and how it affects the cost of living, but ultimately show the inflation and deflation that occurs in an economy.
Inflation rate formula, explained
To have a better understanding of inflation, it helps to know how to calculate it. The inflation rate formula helps determine the increase or decrease in price expressed in a percentage between given years.
Inflation rate = ((B-A)/A) x 100
A= Starting cost
B= Ending cost
In the rate of inflation formula, A is equal to the starting cost of a specific good or service in the CPI for a specific month or year from the past, while B is equal to the ending cost (current cost) in the CPI for that same good or service. When utilizing the inflation rate formula, you will subtract A, the starting cost, from B, the ending cost. The result will show you the difference between these two figures, or in simpler terms, how much the price for that specific good or service has increased or decreased. You will then divide the result by A, the starting cost, which will give you a decimal. Next, you will multiply the result by 100 to turn the decimal into a percentage. The percentage is equal to the rate of inflation.
Inflation rate calculation example
Now that weve talked about the CPI and how to find the inflation rate, lets see the formula in action. Lets use the previous example of a single cup of coffee in the formula for inflation for further understanding of how this all works.
In the example, a single cup of coffee initially costs $3.50. This means that A, or the starting cost, would be equal to $3.50, while B, the ending cost, would be equal to $5.50, since the price increased by $2.00 from your initial purchase.
A= $3.50
B= $5.50
Inflation rate = ((5.50-3.50)/3.50) x 100
Inflation rate = 57%
In this example, the inflation rate for a single cup of coffee would be 57%.
How to calculate the inflation rate over a period of time
You may want to find out how the inflation rate has changed over a specific time period or how inflation might affect you in the future. To do so, lets walk through a few steps on how to find the rate of inflation using the inflation rate equation for a specific time period.
Step 1: Choose a good or service you want to calculate
The first step is to find a specific good or service you want to find the inflation rate for. As previously mentioned, you can find this data in the CPI average price data, the BLS, or do your own individual research.
For example, if you wanted to calculate the inflation rate for a dozen of grade A eggs from January 2012 to January 2015, you would go to the CPI average price data to find the price for a dozen grade A eggs for these years. You will find that the price for a dozen grade A eggs in January 2012 was $1.939, and it cost $2.113 in January 2015.
Step 2: Write it down
Next, you should write down the information in a chart or a list. This will help you distinguish A, the initial price for a dozen eggs, and B, the ending costs.
A dozen grade A eggs in January 2012
$1.939
A dozen grade A eggs in January 2015
$2.113
Step 3: Label each price
As mentioned earlier, the inflation rate formula expresses the initial costs for a good or service as A and the ending costs for a good or service as B. Now lets label each price for the dozen grade A eggs as A & B.
A dozen grade A eggs in January 2012
A= $1.939
A dozen grade A eggs in January 2015
B= $2.113
Step 4: Plug the numbers into the formula
Finally, its time to plug the prices into the inflation rate formula to find the rate of inflation for a dozen grade A eggs. Remember that you are subtracting A (starting cost), which is $1.939, from B (ending cost), which is $2.113. Youll then divide the difference by the starting cost ($1.939) and will be left with a decimal. To turn the decimal into a percentage, you will multiply it by 100 for the inflation rate. Lets try!
Inflation rate = ((B-A)/A) x 100
A= $1.939
B= $2.113
(($2.113-$1.939)/$1.939) x 100
Inflation rate = 9%
The inflation rate for a dozen grade A eggs from January 2012 to January 2015 was 9%.
Other methods of calculating inflation rate
In addition to calculating the inflation rate between specific years, there are also other methods that you can use to find the inflation rate, such as using a base year. When calculating the inflation rate for a specific period of time, you would need to determine what years you would like to calculate. The first year or starting date would be considered your base year. However, you can technically use any year as a base year when calculating inflation. Lets take a look!
Using a base year
Find the CPI
The first step to using a base year is to find the good or service you want to calculate and what specific years you want to find the inflation rate for. Remember that this can be found in the CPI average price data or BLS. When using the average price, you will have to find the CPI for each good and service and choose a base year. The CPI formula is as follows:
CPI = Value of current market basket/Value of basket in the base year x 100
Lets assume that you want to find the inflation rate for a dozen grade A eggs again. Only this time for the time range from January 2015 to January 2016, and you select January 2014 as your base year. In the CPI average price data, the price for a dozen grade A eggs in January 2015 was $2.113, $2.328 in January 2016, and $2.008 in January 2014 (base year).
Now lets find the CPI for a dozen grade A eggs for each year:
- January 2014 (base year): (2.008/2.008) x 100 = 100
- January 2015: (2.113/2.008) x 100 = 105
- January 2016: (2.328/2.008) x 100 = 116
List it out
Now lets list out each CPI and price for a dozen grade A eggs by year.
A dozen grade A eggs in January 2014 (base year)
$2.008 CPI = 100
A dozen grade A eggs in January 2015
$2.113 CPI = 105
A dozen grade A eggs in January 2016
$2.328 CPI = 116
Label each price
In this method, you will label the CPI numbers as the starting number and ending number. So, since January 2015 is the starting date, you will label the CPI equal to 100 as A to represent the starting number, and the CPI for January 2016 as B to represent the ending number.
Inflation rate = ((B-A)/A) x 100
A= Starting number
B= Ending number
A dozen grade A eggs in January 2014 (base year)
$2.008 CPI = 100
A dozen grade A eggs in January 2015
$2.113 A (starting number) CPI = 105
A dozen grade A eggs in January 2016
$2.328 B (ending number) CPI = 116
Plug the numbers into the formula
Lastly, you will plug the CPI numbers into the inflation rate formula to find the inflation rate.
Inflation rate = ((B-A)/A) x 100
Inflation rate = ((116-105)/105) x 100
Inflation rate = 10 %
Inflation rate FAQs
- What is the inflation rate right now?
The current annual inflation rate for the U.S. is 8.3%
- What is a good inflation rate?
In general, policymakers consider an inflation rate of 2% or below to be acceptable.
The bottom line
While the inflation rate has the ability to strengthen or weaken the purchasing power in an economy, its also a key indicator of the overall health of an economy. Understanding the inflation rate formula and how it affects the cost of living and your expenses can help you make important decisions for your finances. Whether the inflation rate increases or decreases, you can better prepare your financial portfolio by using the inflation rate formula as a tool to assess your present and future goals. Download the Public app today to learn more about how to invest in stocks.