Jim Whitney Economics 101

Price levels, inflation, and nominal versus real values

(1) (2) (3) (4) (5)
Year CPI
1982 = 100		 Average hourly earnings in the
private nonagricultural sector		 Real wage
1982 $ Current $ ______
1964 32.1 $2.53 $7.88  
1973 46.0  4.14    
1982 100.0  7.88    
1993 149.7 11.03    
Year before last: ______        
Last year: ______        

1. Computing inflation rates:
Value in  year B - Value in year A    VB    
Formula for a percentage change:   --------------------------------------------  x 100  or ( -----  - 1 ) x 100
Value in year A    VA    

Example:

    Estimated inflation rate for last year: ___________________
 
2. Adjusting values for inflation:
Nominal values (NV) are not adjusted for inflation, so you cannot make direct, meaningful comparisons of nominal values which apply to different time periods. Real values (RV) adjust for inflation and therefore allow you to compare values over time. To convert a nominal value from any year (say, 1964) to its equivalent "real value" in any other year's dollars (say, the current year), you adjust the 1964 value for the difference in prices between 1964 and the current year by using the following formula:

      Real value in current dollars = Nominal value for 1964 · (Pcurrent/P1964).
 
"Current year" is an example of a "reference year"--all other nominal values are converted to their equivalent values in the reference year. The two most popular reference years are:
  1. The most recent year with available data: that option updates all past values to their equivalent values in a time period as close as possible to the present.
  2. The "base year" of the price index under consideration (which is always assigned an index value of 100.0--100% of itself): that option is easiest to work with since:
     
        NVt
      RV in base year dollars = NV for any year t · (Pbase year/Pt) =  --------------
      (Pt/100)

    The result is a commonly used conversion shortcut: to quickly get a series of real values (all expressed in base-year dollars), divide each nominal value by its own price index (divided by 100).

Note: You can rearrange terms to solve for any unknown if you know any two of the values:
            RV = NV/(P/100) => NV = RV·(P/100) and P = (NV/RV)·100.