Deflating a series by price indexes

Many business and economic series reported over time, such as company sales, industry sales, and inventories, are measured in dollar amounts. These time series often show an increasing growth pattern over time which is generally interpreted as showing an increase in the physical volume associated with these activities. In periods where price changes are significant the changes in the dollar amounts may be very misleading unless we are able to adjust the time series to eliminate the price-change effect. Whenever we remove the price-increase effect from the time series, we say we are deflating the series.

In the area of personal income and salaries we often hear discussions concerning issues such as “real salaries” or the “purchasing power”. These concepts are based on the notion of deflating salary index. For example, the following table shows monthly salary income of factory workers for the past 5 years.

Year	Salary ($)	CPI (2000 base)

At first glance, we see sharply increasing trend in monthly salaries, with excellent growth from $490 to $700. Should the factory workers be pleased with this growth in salary? Perhaps yes, but on the other hand, if the cost of living has increased just as fast as salary, maybe the answer is no. If we can compare purchasing power of the $490 in 2000 with the purchasing power of the $700 in 2004, we will have a better idea of the relative improvement in salaries. Table above also shows the Consumer Price Index (CPI) for the period 2000-2004. Here we use 2000 as the base for CPI. With these data we will see how the CPI can be used to deflate the index of monthly salaries. In effect we will be removing the consumer price increases from power of salaries in an attempt to measure the change in purchasing power of the wages.

The calculations used to deflate the salaries are not difficult. The deflated series is found by dividing the monthly salary in each year by the corresponding value of CPI

Year	Deflated salary
	($490/100) ∙100=$490 ($540/105) ∙100=$514.3 ($585/113) ∙100=$517.7 ($640/122) ∙100=$524.6 ($700/138) ∙100=$507.2

What does deflated series of salaries tells us about the “real salary” or “purchasing power” of workers during 2000-2004? In terms of 2000 dollars, the monthly salary has risen from $490 to $507.2 or approximately 3.5% In fact, after we remove the price increase effect we see that factory workers are doing little more than keeping even with the inflationary price increases of the period. Thus, we see that the advantage of using price indexes to deflate a series is that we have a clearer picture of the real dollar changes that are occurring.

Дата добавления: 2015-08-05