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Inflation Formula

Updated on January 29, 2024
Reviewed byDheeraj Vaidya, CFA, FRM

What is the Inflation Formula?

The rise in prices of goods and services is referred to as inflation. One of the measures of inflation is the Consumer Price IndexConsumer Price IndexThe Consumer Price Index (CPI) is a measure of the average price of a basket of regularly used consumer commodities compared to a base year. The CPI for the base year is 100, and this is the benchmark  point.read more  (CPI), and the formula for calculating inflation is:

Rate of Inflation = (CPIx+1 – CPIx ) / CPIx

Where,

  • CPIx is Consumer Price Index of Initial Year
  • CPIx+1 is Consumer Price Index of next year

In certain cases, we need to calculate the rate of average inflation over a number of years. The formula for the same is:

CPIx+n = CPIx * (1+r)n

Where,

  • CPIx is Consumer Price Index of Initial Year,
  • n is number of years after the initial year,
  • CPIx+n is Consumer Price Index of n years after the initial CPI year,
  • r is the rate of interest

Key Takeaways

  • The inflation formula calculates the rate at which the prices of goods and services have increased in an economy over a year. 
  • It is typically measured using the Consumer Price Index (CPI), which can be obtained from reports released by the Bureau of Labor Statistics in the USA.
  • Inflation is a crucial indicator as it impacts the prices of consumer goods and services, affecting the purchasing power of consumers. What a consumer could buy at a certain price last year might be available at different prices in the current year due to inflation. 

Explanation of Inflation Formula

To find out the rate of inflation for one year, follow the given steps:

Step 1: Find out the CPI of the initial year. CPIx denotes it.

Step 2: Find out the CPI of next year. It is denoted by CPIx+1.

Step 3: Calculate the inflation using the formula:

Inflation Equation

Multiply the above number obtained by 100 if you want the inflation rate in percentage terms.

To find out the average rate of inflation over several years, follow the given steps:

Step 1: Find out the initial CPI.

Step 2: Find out the CPI after n years.

Step 3: Use the following formula to find out the rate of inflationFormula To Find Out The Rate Of InflationThe rate of inflation formula helps understand how much the price of goods and services in an economy has increased in a year. It is calculated by dividing the difference between two Consumer Price Indexes(CPI) by previous CPI and multiplying it by 100.read more denoted by r.

Inflation Formula (Equation)

By solving the above equation, we can find out the inflation rate, denoted by r.

Note: Instead of the Consumer Price Index (CPI), some other measures of inflation, such as the Wholesale Price IndexWholesale Price IndexThe Wholesale Price Index tracks the price movement of products in a set territory and wholesaler jurisdiction. Wholesalers provide, manage, and control commodities, usually commonly traded goods, before they are sent to retailers.read more (WPI), may be used. The steps would be the same.

Inflation-Formula

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For eg:
Source: Inflation Formula (wallstreetmojo.com)

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Video Explanation of Inflation

 
 

Examples of Inflation Formula (with Excel Template)

Let’s see some simple to advanced examples of the inflation equation to understand it better.

You can download this Inflation Formula Excel Template here – Inflation Formula Excel Template

Inflation Formula Example #1

The Consumer Price Index (CPI) for 2016 for a certain country is 147. The CPI for 2017 is 154. Find out the rate of inflation.

Solution:

Use the given data for the calculation of inflation.

ParticularsAmount
CPI for 2016147
CPI for 2017154

Calculation of the rate of inflation can be done as follows:

Excel 1.1

Rate of Inflation = ( 154 – 147 ) / 147

Rate of Inflation will be –

Inflation Formula Explanation 1.2

Rate of Inflation = 4.76%

The rate of inflation is 4.76%.

Inflation Formula Example #2

The Consumer Price Index (CPI) for 2010 is 108. The CPI for 2018 is 171. Calculate the average rate of inflation for the years.

Solution:

Use the given data for the calculation of inflation.

ParticularsAmount
CPI for 2018171
CPI for 2010108

Calculation of the average rate of inflation can be done as follow:

Inflation Formula Explanation 2.1

Here, the number of years (n) is 8.

CPIx+n= CPIx * ( 1 + r )^n

(1+r)^n = 172 / 108

1+r = ( 172 / 108 )^(1/n)

r = ( 172 / 108 )^(1/n) – 1

The average rate of inflation will be –

Excel 2.3

The average rate of inflation (r)= 5.91%

The average rate of inflation between 2010 and 2018 is 5.91%.

Inflation Formula Example #3

A common household in a country buys three eggs, four loaves of bread, and 2 liters of petrol each week. The prices of these goods for 2017 and 2018 are as under:

YearPrice of 1 EggPrice of 1 Loaf of BreadPrice of Liter of Petrol
2017$4$2$2
2018$5$2$3

Calculate the rate of inflation for 2018.

Solution:

Calculation of Cost of Basket in 2017 will be –

Cost of Each Good = Price of Good * Quantity of Good
Excel 2.1.0

Cost of Basket in 2017 = $4*3 + $2*4 + $2*2

Cost of Basket in 2017 = $24 

Calculation of Cost of Basket in 2018 will be –

Inflation Formula Calculation 2.2.0

Cost of Basket in 2018 = $5*3 + $2*4 + $3*2

Cost of Basket in 2018 = $29

Calculation of the rate of inflation can be done as follows:

 Excel 3.3.0

Rate of Inflation = ($29 – $24 ) / $24

Rate of Inflation will be –

Inflation Formula Calculation 3.4.0

Rate of Inflation = 0.2083 or 20.83%

The rate of inflation in 2018 is 20.83%.

Inflation Formula Example #4

The prices of certain goods in 2016 and 2017 are as under:

YearPrice of 1 ChickenPrice of 1 Loaf of BreadPrice of 1 Book
2016513
2017624

A common household in a country buys three chickens, two loaves of bread, and two books in a week. Calculate the rate of inflation in 2017.

Solution:

Step 1: We have to calculate the cost of a basket in 2016.

Example 4.1.0

Cost of Basket in 2016 =5*3+1*2+3*2

Cost of Basket in 2016 = 23

Step 2: We have to calculate the cost of a weekly basket in 2017.

Inflation Formula Example 4.2

Cost of Basket in 2017 = 6 * 3 + 2 * 2 + 4 * 2

Cost of Basket in 2017 = 30

Step 3: We calculate the rate of inflation in the final step.

Example 4.3

Rate of Inflation = ( 30 – 23 ) / 23

Inflation Formula Example 4.4

Rate of Inflation = 30.43 %

The rate of inflation is 30.43%.

Inflation Formula Calculator

You can use this inflation formula calculator.

CPIx+1
CPIx
Rate of Inflation Formula=
 

Rate of Inflation Formula=
CPIx+1 − CPIx
=
CPIx
00
= 0
0

Relevance and Uses

Frequently Asked Questions (FAQs)

1. What are the assumptions of inflation formula?

The inflation formula assumes a representative basket of goods, with proportional price changes reflecting the overall cost of living. It assumes no significant changes in consumption patterns and provides a simplified measure of price changes, though it may not fully represent the entire economy.

2. What are the advantages of using the inflation formula?

The inflation formula allows easy comparisons across time and regions, aids policymakers in formulating economic policies, helps businesses and investors in decision-making, and enables consumers to plan budgets and adjust purchasing decisions.

3. What is the inflation formula vs. the deflation formula?

The inflation formula measures the percentage change in the general price level, resulting in a positive percentage, indicating an increase in prices. On the other hand, the deflation formula calculates the percentage decrease in the general price level, resulting in a negative percentage, indicating a decrease in prices. Both formulas are used to assess changes in the purchasing power of money and the overall price level.

This has been a guide to the Inflation Formula. Here we discuss the inflation rate calculation using its formula, examples, a calculator, and a downloadable excel template. You can learn more about financial analysis from the following articles –