Here's how to use the Consumer Price Index to calculate the change in the real value of a dollar over time.
The Consumer Price Index for All Urban Consumers is a valuable tool for understanding how inflation affects the value of a dollar. Every month, the U.S. Bureau of Labor Statistics publishes a new CPI figure, which can be used to calculate the real value of a dollar at a point in time.
The index works as a multiple of the average prices from 1982 to 1984. The average price during this 36-month period was recorded as 100. Thus, if the current reading for the CPI-U index is 180, prices would have increased by 80% since the reference period (1982 to 1984).
Calculating the real value of current dollars
You can use the Consumer Price Index for two periods to see the real value of a dollar in terms of earlier-period dollars. For example, you might want to know how much $100 in today's dollars would buy if prices were the same as in January 1990.
Determining this is simply a matter of division and multiplication, once we have the CPI-U level for the relevant periods:
January 1990: CPI-U stood at 127.4.
November 2015: CPI-U stood at 237.4.
The formula below will help us calculate what November 2015 dollars are worth in terms of January 1990 dollars:
More recent dollars in terms of past dollars = Dollar Amount × Beginning-period CPI ÷ Ending-period CPI.
or
$100 × 127.4 ÷ 237.4 = $53.66
In other words, we know that $100 in Nov. 2015 would buy as many goods and services as $53.66 in Jan. 1990.
Calculating the real value of past dollars
We can also determine what a certain amount of dollars in an earlier year would be worth in a more-recent time period.
Suppose we want to know what $100 in January 1942 would be worth in terms of March 2005 dollars. We can go to the Bureau of Labor Statistics to find the CPI-U for the relevant periods.
January 1942: 15.7
March 2005: 193.3
The formula below calculates the real value of past dollars in more recent dollars:
Past dollars in terms of recent dollars = Dollar amount × Ending-period CPI ÷ Beginning-period CPI.
or
$100 × 193.7 ÷ 15.7 = $1,233.76
In other words, $100 in January 1942 would buy the same amount of "stuff" as $1,233.76 in March 2005.
Some important detail
Because the CPI-U is based on a "basket" of goods, it won't measure the change in price level for a particular good -- say, healthcare or rent. Rather, it shows us how the purchasing power of a dollar has changed over time based on a collection of goods and services purchased by the typical urban consumer in the United States.
However, for what it is intended to do -- capture the changes in average prices over time -- it's very useful for determining the value of a dollar in one year compared to another.
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FAQs
The formula below calculates the real value of past dollars in more recent dollars: Past dollars in terms of recent dollars = Dollar amount × Ending-period CPI ÷ Beginning-period CPI. In other words, $100 in January 1942 would buy the same amount of "stuff" as $1,233.76 in March 2005.
How do you calculate real income from CPI? ›
How do you calculate real income from CPI? Real income for year 2 is equal to nominal income for year 1 multiplied by the CPI ratio (CPI year 2/CPI year 1). If there is a base year, CPI for that year is 100.
How do you calculate real value of money after inflation? ›
To see how inflation affects the value of $1, first divide the inflation rate by 100. Then, multiply that number by $1 (or any starting dollar amount you wish). Then, add that number to your dollar amount.
How to calculate the real value? ›
How to calculate real value from nominal value? To calculate the real value from nominal values you divide the current CPI by the CPI of the base year. Then you multiply this by the price of the good from the base year to figure out the real value of the good.
How do you find the true value of money? ›
The $10,000 you receive today is worth more than the $10,000 you receive in one year. The time value of money reflects this difference. You calculate this difference by multiplying the amount of money you have by the interest rate or investment return you would make on those funds over the period of time.
How to calculate the real value of money using CPI? ›
The formula below calculates the real value of past dollars in more recent dollars: Past dollars in terms of recent dollars = Dollar amount × Ending-period CPI ÷ Beginning-period CPI. In other words, $100 in January 1942 would buy the same amount of "stuff" as $1,233.76 in March 2005.
How do you calculate real return from CPI? ›
The real rate of return is the actual annual rate of return after taking into consideration the factors that affect the rate like inflation and it is calculated by one plus nominal rate divided by one plus inflation rate minus one and inflation rate can be taken from consumer price index or GDP deflator.
What is the real value of money inflation? ›
Real value takes into account inflation and the value of an asset in relation to its purchasing power. In macroeconomics, the real gross domestic product compensates for inflation so economists can exclude inflation from growth figures, and see how much an economy actually grows.
What is the real value of money? ›
Real value is nominal value adjusted for inflation. The real value is obtained by removing the effect of price level changes from the nominal value of time-series data, so as to obtain a truer picture of economic trends.
What is the real value of an investment after inflation? ›
If the nominal rate of return of your financial investments is higher than inflation, the real return on your investment is positive. If the nominal rate of return of your financial investments is lower than inflation, the real return on your investment is negative.
To inflate a past dollar value into present-day dollars, multiply the past dollar value by the ratio of the present year CPI to the past year CPI. For example, assume you want to know what a $1,000 in 1993 would be worth in 2003, based on Seattle area inflation. Thus $1,000 in 1993 is equivalent to $1,345.7 in 2003.
How to convert nominal to real using CPI? ›
To convert a nominal value to a real value the index is used in the same way the deflator is used. The formula is Nominal/CPI x 100.
What actually determines real value? ›
In economics, the nominal value of something is its current price; the real value of something, however, is its relative price over time. Both can be used to talk about the value of not only money, but also your wages, share prices and other things that have financial value.
How is the real value of money measured? ›
The value of money is measured by its purchasing power. Purchasing power is the amount of real goods and services a given nominal amount can purchase. Thus, the higher the price level, the lower the real value of money.
What is real value for your money? ›
Real value is nominal value adjusted for inflation. It can be applied to consumer purchases, such as goods and services, as well as to economic indicators, such as GDP.
What is the formula for calculating the value of money? ›
Present Value and Future Value Calculation Example
For instance, if the present value (PV) of an investment is $10 million, and the amount is invested at a rate of return of 10% for one year, the future value (FV) is equal to: FV = $10 million * [1 + (10% / 1] ^ (1 × 1) = $11 million.
What is the formula for real wage rate with CPI? ›
Real Wage Rate: The average hourly wage rate measured in the dollars of a given reference base period. It shows that the quantity of goods and services that an hour work can buy. Real wage rate = (Nominal wage rate in current year/ CPI in current year) x 100%.
How do you calculate real income from index number? ›
Real income = Nominal income/ Current Price Index * 100.
How do you calculate real interest rate from CPI? ›
To calculate a real interest rate, you subtract the inflation rate from the nominal interest rate. In mathematical terms we would phrase it this way: The real interest rate equals the nominal interest rate minus the inflation rate.
How do you calculate real GDP from CPI? ›
To calculate real GDP using the price index, you divide the price index by 100 to have the price index in hundredths. Then you divide the nominal GDP by the price index in hundredths.
