How To Calculate Inflation Rate: Formula and Example

Updated December 7, 2022

The inflation rate is often the main topic when discussing the economy and the value of the dollar. As a consumer and part of the economic cycle, knowing the basics of inflation is important to understanding how to manage your money.

In this article, we will explore what the inflation rate is, its importance and determine basic steps for how to calculate the inflation rate.

What is an inflation rate?

Inflation rate is the measure of the increase or rate of increase in the general price of selected goods and services over a determined period. Inflation can indicate a decline in the purchasing power or value of a nation's currency and is typically recorded and reported as a percentage.

Inflation rate is important because as the average cost of items increases, currency loses value as it takes more and more funds to acquire the same goods and services as before. This fluctuation in the value of the dollar impacts the cost of living and adversely affects the economy leading to slower economic growth.

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The consumer price index

The consumer price index (CPI) is a measure taken by examining the average prices from a hypothetical basket of goods and services purchased by consumers. Price changes of each item are taken and then averaged. These goods and services include everyday food items like milk, cereal and coffee. However, the basket of goods is not limited to food items only but also includes other items consumers must purchase like transportation expenses, cost of housing, clothing, recreational expenses, toys, furniture, haircuts, tobacco and medical expenses.

The recordings and reporting of prices per item are completed by the U.S. Bureau of Labor Statistics (BLS) every month. Changes in CPI are used to evaluate changes in expenses associated with the cost of living and serve as quantifiable information to determine periods of inflation and deflation for the economy.

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How to calculate the inflation rate

The inflation rate is typically calculated using the inflation rate formula:

(B - A)/A x 100 where A is the starting number and B is the ending number.

The formula requires the starting point (a specific year or month in the past) in the consumer price index for a specific good or service and the current recording for the same good or service in the consumer price index. Subtract to find the difference between the two numbers.

This difference indicates how much the consumer price index for the specific good or service has increased. Divide those results by the starting price (the price reported for the date in the past rather than the current date). This will give you a decimal. To convert this number to a percentage multiply by 100. This will give you the rate of inflation.

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How to calculate the inflation rate for a period

The consumer price index, which measures the variations in price for retail goods and services, is used to help calculate the inflation rate. The inflation rate represents the price increase or decrease of consumer purchased products over a period. In addition to the CPI, you may also use historical price records. The following steps can be applied to calculate the inflation rate for any given or chosen period.

1. Gather information

Determine the goods you will be evaluating and gather information on prices during a period. You can get this information from BLS or do your own research. Keep in mind that the CPI is an average of the price of the goods or services over a period. The number represents an average.

2. Complete a chart with CPI information

Input the information you gathered into a chart that is easy to read. Because the averages are taken monthly and yearly, your chart might reflect that information. You can also use charts and calculators available through the Bureau of Labor Statistics.

3. Determine the time period

Decide how far back you will be going, or how far into the future. You can also calculate the information across any given number of months, years or decades. You may want to try to determine inflation rates for when you retire to calculate how much you want to save. Conversely, you may want to see the rate of inflation since you graduated, or over the past ten years.

4. Locate CPI for an earlier date

On your data chart or the one from the BLS, locate the CPI for the good or service you are analyzing for your starting point. This number is represented in the formula by the letter A.

5. Identify CPI for a later date

Next, focusing on the same good or service, locate the CPI for a later date, often the current year or month. This number is represented in the formula by the letter B.

6. Use the inflation rate formula

Subtract the past date CPI from the current date CPI and divide your answer by the past date CPI. Multiply the results by 100. Your answer is the inflation rate as a percentage.

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How to calculate inflation rate if it is more than 100%

The inflation rate indicates an increase in prices. When the average inflation rate reaches 100, it means that prices for the analyzed goods or services have doubled. When it goes above 100, prices have more than doubled. To help keep information clear, when rates escalate over 100, the BLS typically selects a new base year.

However, when the CPI index is over 100, subtract 100 to determine how much prices inflated in that period. Remember that the data is reflecting an increase on top of the originating price.

Example

For a stronger understanding, let us explore an example:

Provided a gallon of milk cost $5 in 2004 and $5.60 in 2014 we can use these numbers as CPI information to utilize the inflation rate formula. 5.60 minus 5 equals .60. Divide .60 by 5. The results are .12. Multiply by 100. The inflation rate on a gallon of milk between 2004 and 2014 was 12%.


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