You may have heard your grandparents talk about how the prices of goods and services used to be cheap, and you may have wondered how cool it would have been to pay 5 cents for a cup of coffee or 30 cents for a gallon. Why gas? So why have the prices skyrocketed since then and why are you paying almost ten times as much? The answer is inflation.
Understanding inflation is important because it affects every aspect of the economy, from consumer spending to investment returns. Since consumer prices are expected to rise by 4.8% within the next year, which means you’ll soon be paying more for things like housing and groceries, learning what to expect from the future can help you manage your finances. can help in better management of In this guide, we’ll break down the inflation rate with simple terms, so you know how to calculate inflation using the inflation rate formula.
What is the inflation rate?
Inflation is the concept that the prices of goods and services increase over time, reducing the value of currency.
Let’s say you had $7 left in your wallet and you wanted to buy a gallon of milk. If you decided to buy it now and it costs $3.50, you can buy two gallons of milk. However, if you decide to save $7 in your wallet and use it to buy milk later, there is a chance that a gallon of milk will no longer cost $3.50. Instead it may cost $3.80, so you can only buy one gallon of milk. This means that inflation has reduced your purchasing power.
As a consumer you are participating in an economic cycle, and knowing the basics of inflation is important for you to understand how the fluctuating cost of living affects your wallet over time.
why is inflation
Changes in prices due to inflation can happen in every industry and at any time. Typically, inflation is caused by an increase in the cost of production or an increase in demand. Price fluctuations can occur for a number of reasons, such as printing more dollars, and sometimes the price of one commodity rises and another falls.
Generally, the many factors that cause inflation can be classified into three categories:
inflation demand
When the demand for goods and services exceeds the production capacity of the economy.
ExampleConsumers want to buy milk but farmers do not have sufficient supply, resulting in rising milk price.
cost-push inflation
When the cost of producing goods and services increases, the prices of those goods and services also increase.
Example: The cost of equipment and materials needed for milk production increased, which also increases the price of milk.
underlying inflation
When workers expect their wages to increase to maintain their cost of living because the prices of goods and services have increased. These workers expect a steady rise in prices and demand higher wages, which contributes to an increase in the prices of goods and services.
Example: The price of milk rises, and the consumers want to be able to afford the milk, so they request an increase in their wages as well.
consumer price Index
The most common index and indicator of inflation is the Consumer Price Index (CPI), which is completed by the US Bureau of Labor Statistics. The CPI is used to measure the change in cost of living over time. The cost of each item – such as milk, eggs, energy, clothing, transportation, and medical expenses – is taken and averaged on a monthly basis. Then the CPI is calculated by dividing the market basket price in a particular year by the price of the same basket in the base year.
The Consumer Price Index is based on the index average from 1982 to 1984, which was set at 100. So if you see a CPI reading of 140, it indicates a 40% increase in inflation levels. If the reading was 250, the inflation level indicates an increase of 150%.
Inflation Rate Formula
You have to use the inflation rate formula to calculate the inflation rate. This is a simple formula that allows you to see the percentage of increase or decrease in cost between given years. Once you understand the rate of inflation, budgeting becomes easy.
In the formula, A would be the starting point in the consumer price index for a specific good or service, which could be either a specific year or a month. and b shall be the current recording in the Consumer Price Index for the corresponding goods or services.
To use the formula, subtract A from B to find how much the price of that specific good or service has changed. Then divide the result by A (the starting value) which will leave you with a decimal number. Convert the decimal number to a percentage by multiplying it by 100. The result is the inflation rate!
How to Find Inflation Rate for a Period of Time
Now that you understand how the inflation formula works, you’ll want to find out what the inflation rate was in the past or even give an estimate of what you might pay for something in the future. You can use these steps to find the inflation rate:
Step 1: Decide What You Want to Count
Decide which goods or services you want to analyze and for which period you want to find inflation. To do this, you can do your own research or collect average price data from the BLS.
How to do This: Suppose you want to calculate the inflation rate of one gallon of milk from December 1995 to June 2020. If you go over the CPI average data for milk, you will see that the average price of a gallon of milk in December 1995 was $2.518, and in June 2020 it was $3.198.
Step 2: Write the information
Once you decide what you want to calculate, write it down neatly or draw a chart. Make sure you have the price of the item or service for the starting date you set, as well as the price for a later date.
| December 1995 | June 2020 |
| $2.518 | $3.198 |
Step 3: Label the price points
Now that you have the information written down, you’ll see that the formula contains the letters A and B. Label the value for the start date as A, since this is the starting number in your formula. Next, label the second price as B, as that is the last number.
how to do this:
| December 1995 | June 2020 |
| $2.518 =a | $3.198 = b |
Step 4: Plug It Into the Inflation Formula
The final step is to simply plug it into the inflation formula and calculate. You would subtract the starting price (A) from the later price (B), and divide it by the starting date (A). Then multiply the result by 100 to get the inflation rate percentage.
how to do this:
Inflation rate = ((b – a) / a) x 100
Inflation rate = ((3.198 – 2.518) / 2.518) x 100
Inflation rate = (0.68) / 2.518) x 100
Inflation rate = (0.27) x 100
inflation rate = 27%
How to Find Inflation Rate Using Base Year
When calculating inflation over a period of time, you are finding the percentage change from the starting date, which will be your base year. However, you can use any year as the base year to calculate the inflation rate. In case a different year is chosen, the index will also be taken as 100.
Step 1: Find the CPI You Want to Calculate
Decide which goods or services you want to analyze and in which years you want to find inflation. To do this, you can use historical average price data or collect CPI data from the BLS.
If you decide that you want to calculate the average price of a good or service using the following, you must first find the CPI for each of them by choosing the base year and using the CPI formula:
current market basketball price
ICC = –––––––––––––––––––––––––––––––– X 100
Basketball value in base year
how to do this: Let’s say you want to calculate the inflation rate for one gallon of milk from January 2020 to January 2021, and you choose January 2019 as your base year. If you go to the CPI average data for milk, you will see that the average price of a gallon of milk in January 2020 was $3.253, in January 2021 it was $3.468, and the base year price (2019) was $2.913.
Now you have to calculate the CPI for each of these years:
- January 2019 (Base Year): (2.913 / 2.913) x 100 = 100
- January 2020: (3.253 / 2.913) x 100 = 111
- January 2021: (3.468 / 2.913) x 100 = 119
Step 2: Write the information
Once you have the CPI numbers, write them down neatly or draw a chart. Make sure you have the CPI for a good or service for the start date, later date and base year.
how to do this:
| Date | Price | ICC |
| January 2019 (Base Year) | $2.913 | 100 |
| January 2020 | $3.253 | 111 |
| January 2021 | $3.468 | 119 |
Step 3: Label the price points
Now that you have the information written down, you will label the CPI for the start date as A, since this is the starting number in your formula. Next, label the CPI for the second date as B, since that is the final number.
how to do this:
| Date | Price | ICC |
| January 2019 (base year) | $2.913 | 100 |
| January 2020 | $3.253 | 111 = A |
| January 2021 | $3.468 | 119=B |
Step 4: Plug It Into the Inflation Formula
Now just plug it into the inflation formula and calculate. First, subtract the CPI for the start date (A) from the later date (B), and divide it by the CPI for the start date (A). Then multiply the result by 100 to get the inflation rate percentage.
how to do this:
Inflation rate = ((b – a) / a) x 100
Inflation rate = ((119 – 111) / 111) x 100
Inflation rate = (8) / 111) x 100
Inflation rate = (0.072) x 100
inflation rate = 7.2%
More Examples for How to Calculate the Inflation Rate
1. You would like to find out the inflation rate for bananas in March 2014 compared to July 2001. If a pound of bananas cost $0.52 in July 2001 and $0.59 in March 2014, the calculation would be as follows:
Start date: July 2001. Price: $0.52 = A
Expiry date: March 2014. Price: $0.59 = B
Inflation rate = ((b – a) / a) x 100
Inflation rate = ((0.59 – 0.52) / 0.52) x 100
Inflation rate = (0.07) / 0.52) x 100
Inflation rate = (0.07) / 0.52) x 100
Inflation rate = (0.1346) x 100
inflation rate = 13.46%
2. Let us now find the inflation rate for gasoline in July 2021 as compared to January 2002. The price of gasoline in January 2002 was $1.13 per gallon, and in July 2021 it was $3.23. You would first subtract $1.13(a) from $3.23(b), which is 2.1 and divide it by 1.13(a), resulting in 1.8584. To get the percentage, you multiply this by 100, and the inflation rate for gasoline is 185.84% in July 2021 compared to January 2002, meaning the price of a gallon of gas has more than doubled.
3. If you want to find the inflation rate of electricity in January 2018 as compared to January 2018. The CPI for electricity in 2010 was 191.083, and in 2018 it was 213.023. You would first subtract 191.083(a) from 213.023(b), which is 21.94, and divide it by 191.083(a), resulting in 0.1148. Multiply this by 100 to get the percentage, which will be 11.48%.
Now that you know the inflation rate formula and how to use it, you can apply it when making financial decisions. As a consumer, practicing using the formula and understanding how inflation works will help you make important decisions about your living and your future.
Source: Bureau of Labor Statistics
More inflation articles:
Use this free calculator to estimate inflation.
Learn how to use the inflation rate formula.
Review the definition of inflation.
Here’s how inflation affects housing.
