Consumer Price Index (CPI) has a goal of measuring the changes in the price of living. “The consumer price index tries to gauge how much incomes must rise to maintain a constant standard of living.” (Mankiw, 2015). There are 5 steps to measuring the CPI :
1. Fix the Basket
2. Find the Prices
3. Compute the Basket’s Cost
4. Choose a base year
5. Computer the Inflation
CPI must calculate the inflation rate to be able to measure an accurate cost of living. CPI does not include increases in prices, because it is based off fixed prices.
Prices and incomes are slowly rising as the years pass, and it is important to take this into consideration when measuring price of living. A president that earned a $75,000 salary in the 1930s would average to make over 1 million today. Even though $75,000 is quite a bit lower than today’s pay, it was a high pay back in those days. Products were cheaper than today’s as well, so $75,000 went further than it would in today’s economy. Real interest rate is the difference between nominal interest rate and inflation rate. Nominal interest rate measures the rates excluding inflation, while real interest rate includes inflation within its measuring.
Mankiw, N. (2015). Principles of Macroeconomics, 7e, 7th Edition. [VitalSource Bookshelf version]. Retrieved from