April 21, 2018 

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C: The standard abbreviation for consumption expenditures by the household sector, especially when used in the study of macroeconomics. This abbreviation is most often seen in the consumption function, specified as C = a + bY, where Y stands for national income. It is also used for the aggregate expenditure equation, AE = C + I + G + (X - M), where I, G, and (X - M) represent expenditures by the other three macroeconomic sectors, business, government, and foreign.

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The percentage change in the price level from one period to the next. The inflation rate is most commonly presented as an annual average, the percentage change in the average price level from one year to the next. The two most common price indexes used to measure the price level and the inflation rate are the Consumer Price Index (CPI) and the GDP price deflator. The inflation rate is one of several key indicators of business-cycle instability and the overall health of the macroeconomy, with primary focus on tracking the goal of price stability.
The inflation rate, measured as the percentage change in a price index such as the Consumer Price Index or the GDP price deflator, seeks to quantify changes in the average price level. While the inflation rate is generally positive, indicating inflation, it also can be negative, indicating deflation. Should a positive inflation rate decline over time, then disinflation occurs.

The Historical Trend

Inflation Rate
Inflation Rate
As indicated in the accompanying graph, the inflation rate (computed using the CPI) tends to vary over the course of business-cycle activity, rising during expansions and falling during contractions. The range is usually under 6 percent, but it has been as high as 14 percent. During the expansion that occupied the better part of the 1960s, the inflation rate rose from the 2 percent level to 6 percent. During the contraction of the early 1990s, the inflation rate fell back from 6 percent to 2 percent.

The most noted feature of this graph is the double spike of inflation during the 1970s, reaching one spike of about 12 percent in the early 1970s, then after declining during the 1973-75 contraction, hit an even higher peak of 14 percent in 1980. The 1970s is notable as the decade of stagflation, simultaneous high rates of both inflation and unemployment.

Another, perhaps less obvious but also important, feature of this graph is the declining inflation during the expansion of the mid 1980s and through much of the 1990s expansion. Rather than inflation rising during expansions, inflation actually declined. The 1980s decline was likely due, as much as anything, to a reversal of the factors causing the stagflation of the 1970s (energy prices, government regulations) while the 1990s decline was likely attributable to technology-induced economic growth.

A Simple Formula

The inflation rate is a relatively straightforward calculation of the percentage change in the price level, measured by a price index such as the CPI or GDP price deflator. As illustrated in the following equation, the inflation rate is simply the change in the price index from one period (usually year) to the next, divided by the price index in the original period. This change is then multiplied by 100 to put it the result into an easily recognizable form.

inflation rate=index for period 2 - index for period 1
index for period 1
x 100

Crunching the Numbers

Consider a calculation or two to demonstrate. If the GDP price deflator is 150 in year 1 and 155 in year 2, then the inflation rate is 155 minus 150, divided by 150. Adjusting to percentage terms by multiplying by 100 results in a 3.3 percent inflation rate.

inflation rate=155 - 150
x 100=3.3 percent

A more recent realistic calculation can be done for 2003 using the CPI. The CPI was 179.9 in 2002 and 184.0 in 2003. Plugging these numbers into the formula gives 184.0 minus 179.9 divided by 179.9. In percentage terms this is a 2.3 percent inflation rate, as illustrated here:

inflation rate=184.0 - 179.9
x 100=2.3 percent

Annualized Numbers

While the inflation rate is commonly calculated for annual changes in the price level, annualized inflation rates for other periods, especially months for the CPI and quarters for the GDP price deflator, are also frequently reported. For example, the inflation rate from June 2003 to July 2003 can be calculated using the CPI. Or the inflation rate from the first quarter 2003 to the second quarter 2003 can be calculated using the GDP price deflator. When inflation rates are calculated for periods less than a year, they are generally adjusted to annualized rates. This requires a slight modification in the formula, multiplying by the number of periods per year (12 for monthly, 4 for quarterly).

inflation rate=index for period 2 - index for period 1
index for period 1
x 100 x periods per year

To illustrate, consider that the CPI for June of 2003 is 183.7 and for July of 2003 it is 183.9. Inserting this values into the formula gives:

inflation rate=183.9 - 183.7
x 100 x 12=1.3 percent

The ACTUAL percentage change from June 2003 to July 2003, the ACTUAL inflation rate, is 0.109 percent. This, however, is the percentage change in the price level from one month to the next. Because people are accustomed to working with ANNUAL changes in the price level, it is more convenient to convert this monthly inflation rate to an annualized inflation rate. This is accomplished when 0.109 percent is multiplied by 12, the number of months per year. This step produces the 1.3 percent inflation rate noted in the calculation.

Care should be taken when interpreting the inflation rate calculated in this manner. The inflation rate is NOT 1.3 percent for July 2003. The price level did NOT increase by 1.3 percent from June 2003 to July 2003. The correct interpretation is that the inflation rate would be 1.3 percent if the price level increased at the same pace for 12 MONTHS as it did from June 2003 to July 2003. Of course, the price level might actually rise at a faster or slower pace than that between June and July, meaning the ACTUAL inflation rate for the 12-month period might be more or less than 1.3 percent.

The annualized inflation rates are convenient because they enable comparison from one month the next. For example, the ACTUAL percentage change in the CPI from July 2003 to August 2003 is 0.272 percent. While a comparison with the 0.109 percent for July suggests that inflation is greater in August, how much greater is not readily obvious. The annualized inflation for August rate, however, is 3.3 percent. By working with annual inflation rates, comparing 1.3 percent for July with 3.3 percent for August is a little more meaningful.


Recommended Citation:

INFLATION RATE, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2018. [Accessed: April 21, 2018].

Check Out These Related Terms...

     | price level | price index | deflation | disinflation | inflation problems | inflation causes | Consumer Price Index | GDP price deflator | demand-pull inflation | cost-push inflation |

Or For A Little Background...

     | inflation | business cycles | business cycle indicators | expansion | macroeconomics | macroeconomic goals | macroeconomic problems | gross domestic product | real gross domestic product | production possibilities | nominal gross domestic product |

And For Further Study...

     | unemployment rate | Bureau of Labor Statistics | Bureau of Economic Analysis | cost of living | Producer Price Index | Wholesale Price Index | CPI and GDP price deflator | National Income and Product Accounts | inflationary expectations, aggregate demand determinant |

Related Websites (Will Open in New Window)...

     | Bureau of Economic Analysis | Bureau of Labor Statistics |

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