Calculating the Inflation Rate

The CPI is just a number that tracks the average price of a fixed basket of goods relative to a base period. To turn two CPI readings into an inflation rate, you treat it like any percent change: subtract the old value from the new value, divide by the old value, and multiply by 100. The formula is (CPI_new minus CPI_old) divided by CPI_old, times 100. A positive result means prices rose over the period; the size of the number tells you how fast.

This is why falling inflation does not mean falling prices. Inflation is a rate of change, not a level. If the rate drops from 6 percent to 3 percent, prices are still climbing every year, just less steeply than before. That slowdown has its own name, disinflation, and it's easy to confuse with deflation, which is when the price level actually drops and the inflation rate itself goes negative. Picture the price level as a line on a graph: disinflation is the line still climbing but curving to a gentler slope; deflation is the line actually heading downward.

This calculation is the bridge between Unit 2's price-level tools and everything built on top of them later: real versus nominal comparisons, the real interest rate, and how the Federal Reserve reads inflation data to set policy. Get the mechanics of the percent-change formula solid here, because every later unit assumes you can move between an index number and a rate without hesitating.