Why deflate prices

By adjusting for inflation, you uncover the real growth, if any. Inflation-adjustment is not always necessary when dealing with monetary variables--sometimes it is simpler to forecast the data in nominal terms or to use a logarithm transformation for stabilizing the variance--but it is an important tool in the toolkit for analyzing economic data.

The Consumer Price Index is probably the best known US price index, but other price indices may be appropriate for some data. The U. Bureau of Economic Analysis compiles a wide array of "chain-type" price indices for various kinds of personal consumption goods.

A chain-type index is one that is obtained by chaining together monthly, quarterly, or annual changes in relative prices that are adjusted for changes in the composition of the commodity basket, so as to reflect changes in consumer tastes. For more details on chain-type indices, see the following article.

There are some striking differences: the price of gasoline has experienced large downward as well as upward movements due to shocks to the world economy, tobacco prices have risen in large part due to taxation, the price of a college education has gone up dramatically in stair-step fashion, and the price of computers has shown an exponential decline rather than exponential growth.

The ordering of the series in the legend is the same as their rankings in , except that the all-items index should be ranked below rather than above fast food.

However, deflation by a general-purpose index such as the CPI is often adequate for rough estimates of trends in real terms when doing exploratory data analysis or when fitting a forecasting model that adapts to changing trends anyway. Keep in mind that when you deflate a sales or consumer expenditures series by a general index such as the CPI, you are not necessarily converting from dollars spent to units sold or consumed, rather, you are converting from dollars spent on one type of good to equivalent quantities of other consumer goods e.

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Measure content performance. Develop and improve products. List of Partners vendors. Value deflation, or shrinkflation , occurs when retailers and service providers cut their costs and sell smaller packages, give out smaller portions, or generally provide less for the same price so as to maintain the same sticker price. Businesses may do this as a way of stealthily raising prices when costs are rising and consumers are particularly price-conscious.

Economy-wide value deflation is actually a form of price inflation to the extent that it results in lower real consumption at the same price level. Value deflation can lead to an understatement of the rate of inflation and the cost of living if it is not accounted for in the calculation of price indexes. Value deflation is a way of raising prices, so the consumer is less likely to notice, and it can take the form of reductions in the amount of food in a typical package, reduced portion sizes at restaurants, increased wait times, and reduction in customer service and support, or switching to lower-cost ingredients or materials.

It can be a successful tactic because a lot of shoppers are more sensitive to a price change than to a quality change. From a marketing standpoint, shrinking packages is better than raising prices in order to maintain a consistent price point.

But value deflation can backfire, as Kraft discovered when it shrunk its Toblerone bar in and made headlines in the United Kingdom.

British food retailers have made such extensive use of value deflation to compensate for the weak pound and the increased cost of imported ingredients that shrinkflation has become a phenomenon. Over 2, products were subject to value deflation from to , according to the Office for National Statistics. Value deflation may not show up in inflation measures such as the consumer price index or the retail price index.

Many economic statistics agencies use quality adjustment processes to isolate price movements from the changes in a product's weight or quality, so in there it should still show up as a price rise in official inflation statistics.

However, many of the techniques of value deflation may, by design, be difficult to measure. Manufacturers might switch to lower-cost inputs without greatly changing the product. If you wanted to perform the same calculation on a spreadsheet, it would look like this:. For modeling purposes, the choice of a reference point doesn't matter, since changing the reference point merely multiplies or divides the whole series by a constant.

To move the reference point to a different base year, you would just divide the whole price index series by the current value of the index at the desired reference date. However, the parameters of a model are easier to interpret if the same reference point is used for all inflation adjustments. The thing you wish to avoid at all costs is having some variables which are inflation adjusted and others which aren't : this will introduce apparent nonlinear relationships which are merely artifacts of inconsistent units.

The following spreadsheet illustrates how you could adjust the auto sales series to dollars instead of dollars. First, the CPI series is divided through by its original value in January , to obtain a new consumer price index series called CPI70 in which the value is equal to 1. Then the auto sales series is divided by the CPI70 index:.

Of course, the graph of the auto sales series in dollars would look identical to the graph in dollars: only the axis scale numbers would change.