0
$\begingroup$

I know that inflation rate = $$ CPI_{n} - CPI_{n-1} \over CPI_{n-1}$$

but I wonder what's the point of dividing by $CPI_{n-1}$, CPI is already a percentage so inflation rate should be $ CPI_{n} - CPI_{n-1}$ directly (eg. Assume base year is 2003 and CPI in 2010 was 105% and CPI in 2021 was 120% then should not inflation rate be 120% - 105% = 15%?)

I suspect we do that because we often tend to think of CPI as in dollars instead of percentage, so for example we can say that what could be bought with 1 dollar in 2003 would be bought with 1.20 dollars in 2021 so we still need to divide by $CPI_{n-1}$ when calculating inflation rate? but I'm still confused tho.

Thanks in advance (and please ignore how unrealistic my example was, I made that up for demonstration)

$\endgroup$
4
$\begingroup$

Because inflation is defined as a positive growth rate of CPI.

By definition growth rate is:

$$g=\frac{x_t-x_{t-1}}{x_{t-1}} \tag{*}$$

That is just how growth rate is defined in sciences anywhere from physics or biology to social sciences.

It does not matter if the number is in percentages. A growth rate of interest rate is still calculated by the same equation *.

$x_t-x_{t-1}$ is just simple change, not growth rate.

Assume base year is 2003 and CPI in 2010 was 105% and CPI in 2021 was 120% then should not inflation rate be 120% - 105% = 15%?

No in that problem CPI changed by 15 points, inflation rate in your example is $0.1429$ or $14.29\%$. Note inflation does not need to be expressed in per cent terms - in many research papers it’s just in decimals.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.