In 1980, nominal US GDP was roughly $2.9 trillion. How does that compare to today’s economy of over $21 trillion? We know we aren’t producing seven times as much stuff because some of this is due to inflation. Between 1980 and today prices have approximately tripled. And so, real 1980 GDP (stated in 2019 prices) would be about $9 trillion. So, real production has increased, but only by a little more than double.
How do we determine what prices in general have done over time? The Bureau of Labor Statistics (a branch of the US government) actually goes out monthly and prices a fixed basket of goods and services purchased by a typical urban household. The middle column in the following table is the amount a hypothetical basket of goods costs in each of the given years. In 1973, these goods and services cost a total of $4,652. In 2013, this same basket cost $65,541. From this we can determine that prices (for the typical urban household) have increased roughly twelve times over the past 40 years.
Basket Total | Indexed (1983=100) | |
1973 | $4,652 | 44 |
1983 | $10,571 | 100 |
1993 | $15,222 | 144 |
2003 | $28,009 | 184 |
2013 | $65,541 | 234 |
But to make the numbers easier to work with, the BEA creates a simple index by converting each total to a percentage of a selected year. For this series, the BEA chose to use 1982 as the base year. The 1973 basket total was what percentage of the 1982 basket total? $4,562/$10,571 = .44 or 44%. The 1973 “consumer price index” number is 44. What about 2013? $65,541/$10,571 = 2.34 or 234%. The 2013 CPI number is 234. And of course, the 1983 basket cost 100% of the 1983 basket price. The base year CPI will always be 100. This data has been constructed and is available all the way back to 1913.
Example – In 1931, during the height of the Great Depression, nominal GDP was $77.4 billion. The 1931 CPI was 15.2 while the 2019 CPI was 255.7. Based on these CPI numbers, prices in 2019 were 255.7/15.2 = 16.8 times higher. And so, to make the 1931 GDP comparable to 2019 GDP we need to increase it 16.8 times. 1931 Real GDP (in 2019 prices) = $1,300 billion – a mere fraction of the over $21,000 billion in 2019.
REAL GDP = nominal GDP X (CPI of year converting to/CPI year converting from)
REAL GDP = $77.4 billion X (255.7/15.2) = $1,300 billion
Example – Of course, CPI data can be used to convert any historic financial figure to current prices. For example, in 1931 Babe Ruth earned an annual salary of $80,000. How much would that be today? Even adjusting for inflation, Babe Ruth earned only a little more than one million per year at the height of his career. Things have changed apparently.
REAL Salary = $80,000 X (255.7/15.2) = $1,344,000
There are other price indices beyond the consumer price index used here. Certainly, for adjusting inflation numbers it isn’t the best choice. But it is the most commonly quoted and is used for most practical decisions (e.g. cost of living raises).
Measuring Inflation
You almost certainly have heard the word inflation used from time to time. Inflation is simply the annualized increase in the price level. In January 2018, the CPI was 251.107. In January of 2019, it had increased to 255.657. By measuring the change we can calculate inflation.
Inflation = (New Price Level – Old Price Level)/Old Price Level X 100
Inflation = (255.657 – 251.107)/251.107 X 100
Inflation = 4.55/251.107 X 100
Inflation = .018 X 100
Inflation = 1.8%
This diagram represents year-over-year inflation since 1950. As you can see inflation was quite high during the mid and late 1970s, but has been relatively low ever sense. In 2009, we even had a brief moment when prices in the economy fell overall for a very brief time. Deflation, as this is called, hadn’t occurred since the Great Depression. Both high inflation and deflation are problematic for an economy. Inflation tends to make long-term decision making difficult causing distortions to financial decision making. Deflation can be even more problematic by undermining financial institutions.