Formula to Calculate the Rate of Inflation
The rate of inflation formula helps us to understand how much the price of goods and services in an economy has increased in a year. For example, if the price of goods and services in an economy is now $103 and in the previous year the same was $100, then, the inflation is $3. Below is the given formula through which we can calculate the rate of inflation.
Here, CPI x means the initial consumer index.
The CPI of the previous year was $1000 and the CPI for the current year is $1110. Find out the rate of inflation for this year.
This example is a fictitious one and we took this example to simplify the understanding of the rate of inflation.
- Here we have the previous year’s CPI, i.e. $1000.
- And we also know the current year’s CPI, i.e. $1110.
Using the formula, we get –
Rate of Inflation = (CPI x+1 – CPI x) / CPI x
- i.e = ($1110 – $1000) / $1000 = $110 / $1000 = 11%.
- In a normal scenario, the inflation rate is around 2-3%. Normally, the inflation rate doesn’t reach 11% at all.
- In the above formula, we used the consumer index for the previous year and the next year and then we found out the difference between these two.
- Later, we divided the difference by the previous year’s consumer price index.
Let’s take a simple example to understand why the consumer price index is taken.
- Every year, the government issued new notes into the economy. With the newly issued notes, the value of the currency decreases. As a result, whatever was available at $100 wouldn’t be available at $100 in the next year.
- John went to the market and bought groceries for $200. He was happy because, under $200, he got everything.
- Next year, John has gone to the market again to buy the same groceries in an equal amount. He took $200 because he knew from his previous experience that they would only cost $200. But to his utter surprise, he saw that now he would need to pay $210 for the same amount of groceries. This ($210 – $200) = $10 is the inflation.
- And the rate of inflation in the same scenario would be = $10/$200 = 5%.
Use and Relevance of Rate of Inflation Formula
- We can gather information about the Consumer Price Index (CPI) from the report released by the Bureau of Labor Statistics, USA.
- It is an important measure because it affects not only the prices of consumer goods and services; it also affects the purchasing power of every customer.
- What a customer could buy in the previous year wouldn’t be available in the next year under the same prices. The price of the goods or services will increase.
- One thing we need to keep in mind is that the rate of inflation and the purchasing power isn’t the same things.
- It is the rate of increase in the prices due to the under-valuation of currency. On the other hand, purchasing power is the person’s ability to buy goods and services as per his/her income.
Rate of Inflation Calculator
You can use the following Rate of Inflation Calculator
|Rate of Inflation Formula=||
Rate of Inflation Formula in Excel (with excel template)
Let us now do the same example above in Excel.
This is very simple. You need to provide the two inputs of the previous year’s CPI and current year’s CPI.
You can easily calculate the ratio in the template provided.
This has been a guide to the Rate of inflation Formula. Here we provide practical examples and rate of inflation calculator along with excel templates. You may also have a look at these articles below to learn more about Financial Analysis –