The formula for calculating the Inflation Rate using the Consumer Price Index is relatively simple. Every month the Kenya National Bureau of Statistics (KNBS) surveys prices and generates the current Consumer Price Index (CPI).
What is this CPI?
The CPI is defined as a measure of the weighted average change in retail prices paid by consumers for a given basket of goods and services. Price changes are measured by re-pricing the same basket of goods and services at regular intervals, and comparing the current cost with the cost of the same basket in a selected base period or base year.
A convenient way of thinking about the CPI is to imagine a very large “shopping basket” full of goods and services on which people typically spend their money. The contents of the basket are fixed at a particular point in time, but as the prices of the individual commodities in the basket change so does the price of the basketful.
In Kenya the basket of goods comprises of the following categories of goods and services:
- Food and Non-Alcoholic beverages
- Alcoholic beverages, Narcotics and Tobacco
- Clothing and Footwear
- Housing, Water, Electricity and other Fuels
- Furnishings, Household Equipment and Routine Household Maintenance
- Health
- Transport
- Communications
- Recreation and Culture
- Education
- Hotels and restaurants
- Miscellaneous goods and services.
Price data for constructing the indices are collected by Kenya National Bureau of Statistics through a survey of retail prices for consumption goods and services.
Calculating CPI
Let us assume for the sake of simplicity that the index consists of one item and that one item cost KES 1.00 in 1994. The KNBS published the index in 1994 at 100. If today that same item costs KES 1.85 the index would stand at 185.0
Clearly, from this we can see that the index increased (it went from 100 to 185). The question is by how much has it increased? To calculate the change we would take the second number (185) and subtract the first number (100). The result would be 85. So we know that since 1994 prices increased or have inflated by 85 points.
What good does knowing that it moved 85 do? Not much. We still need a method of comparison.
Since we know the increase in the CPI we still need to compare it to something, so we compare it to the price it started at (100). We do that by dividing the increase by the first price i.e. 85/100. The result is (.85). This number is still not very useful so we convert it into a percent i.e. 85%.
So the result is an 85% increase in prices since 1994.
Calculating a Specific Inflation Rate
Normally, we want to know how much prices have increased since last year, or since we bought our house, or perhaps how much prices will increase by the time we retire or our kids go to college.
Fortunately, the method of calculating inflation is similar, no matter what time period we desire. We just substitute a different value for the first one. So if we want to know how much prices have increased over the last 12 months (the commonly published inflation rate number) we would subtract last year’s index from the current index and divide by last year’s number and multiply the result by 100 to get the percentage. The formula for calculating the Inflation Rate looks like this:
((B – A)/A)*100
(Where: B is Base Year Index/Last Year’s Index and A is the Current Index)
So if exactly one year ago the Consumer Price Index was 143 and today the CPI is 160, then the calculations would look like this:
((160-143)/143)*100
or
(17/143)*100
or
0.11888*100
This equals 11.888% inflation over the sample year. (Obviously this is not the actual Inflation Rates it is for illustration purposes).
What happens if prices go down?
If prices go down and we experienced Price Deflation then “A” would be larger than “B” and we would end up with a negative number. So if last year the Consumer Price Index (CPI) was 189 and this year the CPI is 185 then the formula would look like this:
((185-189)/189)*100
or
(-4/189)*100
or
-0.021*100
This equals negative 2.11% inflation over the sample year. Of course negative inflation is deflation.
So that’s how inflation is calculated.