If you have a price at 2.10 and a CPI at 40.5 how do you find the real price?

Question

If you have a price at 2.10 and a CPI at 40.5 how do you find the real price?

Answer 1

Real Price = Nominal Money Price * VAlue of money

If Value of money goes up, Real Price increases, If value of money goes down real price falls.

Value of money (ie, purchasing power of money) is what a dollar can buy at given prices and therefore value of one dollar equals $(1/ CPI)*100

The base year CPI is 100. The value of money in the base year was (1/100)*100= 100

The value of money now = (1/ 40.5)*100.= 246.91358

Thus the value of money has gone up nearly 2.47 times.

The real price therefore has increased in the same proportion.

Real Price=  Nominal Money price*Value of money=

     = 2.10*2.4691358 = 5.18518518

ie $5.19 approximately.

What does this mean? It means the product you are buying today in real (base year) purchasing power terms would have cost $5.19. Since the Price Index has fallen you are getting this today so much cheaper. Alternatively, it means that since the CPI is lower now, the real value of your $1 income today is equivalent to $2.47 of income in the base year. Therefore, what cost today at $2.10 is actually equivalent to spending $5.19 in terms of purchasing power of the base year. So, you are better off today.