HOW TO USE THE CPI: converting to constant dollars

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HOW TO USE THE CPI converting to constant
dollars
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• One use for the CPI is to appropriately compare
  costs of specific items over the years.
• For example the average price of gasoline in 1990
  was 1.16 per gallon.
• In 1997, the average price was 1.23.
• The price seems to have gone up, but lets see
  what the index tells us.

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• The CPI in 1990 was 130.7 and in 1997 it was
  160.5. We interpret this as meaning
• 130.7 in 1990 ? 160.5 in 1997
• 1 in 1990 ? 160.5/130.7 in 1997
• so we have that
• 1.16 in 1990 ? 1.16 160.5/130.7 in 1997
• ? 1.42 in 1997

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• So someone paying 1.16 in 1990 for a gallon of
  gasoline was equivalent to someone paying 1.42
  per gallon in 1997.
• But the average price of a gallon of gas in 1997
  was only 1.23 so it was cheaper in 1997 than it
  was in 1990.
• Finding the equivalent cost in another year is
  called converting to constant dollars. We found
  that the price of gasoline in 1990 was 1.42 in
  constant 1997 dollars.

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• Youll notice that this is very similar to our
  currency exchange activity we couldnt really
  compare the price of the sweater (note, NOT
  sombrero) in Mexico to the price we would have
  paid in Chicago until we converted the Mexican
  Peso price into US dollars. We could have
  converted in the other direction also, of course.

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• This is the same idea we want to know how the
  gasoline price in 1997 compared to the gasoline
  price in 1990. Here our two different
  currencies are
• The 1997 US Dollar and
• The 1990 US Dollar.
• Even though they are all US Dollars, 1 signifies
  something different every year.

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• When you were asked to compare two different
  currencies (like the French Franc and the Chinese
  Yuan) you probably found it helpful to convert
  both into US Dollars and then compare them to
  each other.
• This is also helpful when comparing prices over
  many years. For example we would like to see if
  DePaul tuition really went up (considering into
  account inflation). We would pick a year and
  convert all the DePaul tuition prices into
  constant dollars for that year, then compare
  them.

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• You get to try this in your next activity!