Inflation rate formula

With the recent talk of inflation and a recession, there is plenty of economic uncertainty, with some people worried. It’s helpful to understand the inflation rate, how it’s calculated, and what it means, because it provides insight into the economic future.

The inflation rate is one of the main markers to help determine where the economy is and how the average person is affected. Knowing how to calculate the inflation rate using the inflation rate formula can guide you on what steps to take in your career or in how to manage your money.

What is inflation?

Inflation refers to products, goods, and services rising in price over time. When inflation gets too high, it can cause distress to the economy. People slow down their spending because of the unaffordability of goods and services. Consequently, high inflation can lead to a recession in some instances. Either way, it causes most people to take notice and change their spending habits.

A small amount of inflation is necessary so that consumers will spend money. If the country faces too low of an inflation rate, it causes deflation, which is just as bad. A balanced inflation rate is ideal.

What is the inflation rate?

The inflation rate is expressed as a percentage and consists of the rate of increase in the average price of certain goods and services over a specified period.

You can also look at the inflation rate as how the dollar loses its value when the cost of items increases. For example, chances are your dollar today can’t buy you the same things that your dollar could buy you two years ago (or even one year ago). That’s because of the inflation rate.

When inflation goes up, the currency value changes. People begin to put their money away in savings, stocks, and investments when it changes too drastically. They don’t want to spend the money because they’re waiting for the value to return.

The impact of the inflation rate on currency can cause a lag in spending, and the economy becomes sluggish, meaning it has an adverse effect on the cost of living.

Components of the inflation rate

Two main measures go into calculating the inflation rate. They both bring you to the same result but get there in a different way. These are as follows:

Consumer Price Index (CPI)

The CPI is the most used way to measure the inflation rate and will be used in the inflation rate formula below. This number is determined by the Bureau of Labor Statistics (BLS). It consists of what the average cost is from a hypothetical basket of products and services. Some of these goods include groceries, automobiles, electronics, fuel, housing, clothing, medical expenses, furniture, beauty supplies, and so on. The BLS takes into consideration the changes in prices from store to store and uses the average. Price changes of each item are taken and then averaged.

The BLS lists this information monthly so that consumers can monitor the changes in the cost of living and report it accordingly.

Personal Consumption Expenditures (PCE) Price Index

The PCE is similar to the CPI, but the main difference is how they get the price amount from the goods and services. With CPI data, the information comes from the consumer spending amount for goods and services, whereas the PCE gives the data from the businesses’ point of view. In other words, the businesses report how much they sell their goods and services for.

How to calculate the inflation rate formula

To calculate inflation, you need to use the inflation rate formula, which is as follows:

(B-A)/Ax100 = inflation rate (as a percentage). A represents the cost of goods in the past, and B represents the current cost of goods. Here are the steps to determining what the inflation rate would be on an item:

Step 1: Consult the data

Your first step involves consulting the consumer price index (CPI) data for the product or service you wish to analyze. You can retrieve this information from the Bureau of Labor Statistics (BLS). Alternatively, you could obtain the information yourself by doing research. Just be sure to get a representative sample and then average the prices.

Step 2: Check the chart for the correct time periods

Whether you decide to get the CPI information from the BLS or research yourself, make sure you select the appropriate time period. When researching the information, you will need to get prices for the item on the same day since prices can fluctuate from day to day.

To extract the information about the past price (for comparison), you will need to use the BLS charts. Due to seasonal shopping and pricing trends, you’ll get a more accurate inflation rate if you select the CPI from the same month.

Step 3: Run the calculation

Now that you have the two main numbers you need, you’re ready to plug them into the formula. You can do this by hand or use a calculator for better accuracy.

Step 4: Analyze the results

The last step is optional, but it’s beneficial. You can analyze the results of the calculation. What does it tell you? Do you need to adjust your spending habits at all? Experts say that a 2% inflation rate or lower is ideal. If it’s much higher than that, it could affect economic spending.

Inflation rate formula with an example

Let’s look at an example to understand how the inflation rate formula works in action:

If a gallon of gas costs $2.11 in December 2015 and $3.44 in December 2021, we can run the inflation rate formula to find out how much the inflation is on gas. (B-A)/Ax100

$3.44 minus $2.11 equals $1.33. Divide $1.33 by $2.11. The result is .63. Multiply this by 100. The inflation rate on a gallon of gas between 2015 and 2021 is 63%.