I wonder how many people in countries like the United States, Switzerland, Brazil, Canada, Russia, and China would be surprised to learn that prices of products and services in their countries have become much less expensive over the years.

Say what? You must be crazy, you say! Prices are rising too fast!

Yes, most citizens see their purchases as becoming more expensive when, in actuality, things are becoming less expensive. Of course, the paradox is that although nominal prices (the actual price tag) are, in fact, increasing, nominal income (the average wage) has been growing faster. This is a topic that in economics is called “real income” or a measurement that compares a nation’s income growth relative to the growth in prices that the same income buys.

Let’s take some specific facts:

In the United States real median household income grew from $41,318 to $50,811 from 1970 through 2006 for a total percentage gain of 23% (source: Pew Research Center). Both of the aforementioned median household incomes are stated in 2008 or current dollars which makes the comparison valid. Median household income is an attempt to quantify the progress that the “middle American” family or typical family has made. So, in short, the median household in America can buy 23% more with their income today than they could in 1970. In other words, relative prices are lower to income.

If we look at the same United States income data over the same period for real average household income, there is real income growth of nearly 60%. The higher growth rate (60%) in real incomes for the average household versus the median (middle) growth rate (23%) is explained by the fact that much of the growth in United States’ real incomes has accrued disproportionately to the college educated & entrepreneurs driving up real income growth rates much faster for the “average” than the median or middle household. (Hint: continue your education!)

Now let’s get back to the main premise of the title of this blog and the opening assertion that prices are lower than ever. What we are really saying is that you have to benchmark price increases to income increases to really understand whether things are becoming more expensive. The vast majority of products & services are cheaper today in all nations than they have ever been before, which helps explain why more citizens than ever before can afford to own their own houses, drive more and better cars, have cable and computers. The reason we are led to believe differently is because we are victims of our own human nature which tend to focus on the problem areas (higher relative prices) and not the benefits (lower relative prices). Most all citizens expand out to the last dollar of our incomes and quickly notice about those products that are rising faster than normal like gasoline prices! Hey, even gasoline prices are barely at an all relative price high. If gasoline prices are restated for inflation they are $3.50 today vs. $3.17 in 1981 and $3.50 in 1918!

Now, you may say to yourself that statistics can lie or mislead and you are sure in your gut that things are getting more expensive relatively. You can try to validate that incorrect “gut feeling” by examining whether your country’s middle class is enjoying less or more products and services. “Real income” really is just a measurement of the quantity and quality of products and services that you have. The median and average American continually has more actual products & services in the aggregate as U.S. income gains have averaged 3.5% per year outpacing higher price increases averaging 3.0% per year leading to a real gain in products and services. True, there are many individual products and services that have risen in price faster than incomes (and big ones like education, energy, and health care!) but we must look at the whole picture of all prices to understand how our citizens, on average, are becoming economically better off.

All of Inflation’s Little Parts - The New York Times

This is really cool… The Bureau of Labor Statistics releases monthly data on prices to let Americans know just how much inflation affects their livelihoods. The Consumer Price Index, which is studied in both AP and IB Economics, consists of a “basket of goods”, that when bundled together represent the “typical” American consumer’s expenditures. The CPI is broken into a few broad categories:

Here’s the cool part, though… within each broad category the BLS tracks the prices of dozens of specific categories, around 200 to be precise. Each of these is then broken down into individual products, around 84,000 in total! The task of tracking the prices of 84,000 individual goods and services every month is daunting, and just thinking about the tedium of this job makes me glad I’m a teacher!

The New York Times has assembled what can only be described as a mosaic of consumption, organizing the 200 specific CPI categories into what looks like an ornate stained-glass window, in which the size of each piece of glass represents the percentage of Americans’ income that go towards each specific category. Some of the categories represented in this mosaic include items such as:

This graphic is a great tool for teaching and understanding the Consumer Price Index, not to mention a beautiful pattern for any stained-glass artist looking for inspiration!
nyt-cpi-graphic