Forex

Determining the relative value of an amount of money in one year compared to another is more complicated than it seems at first. There is no single "correct" measure, and economic historians use one or more different indicators depending on the context of the question.

Most indices are measured as the price of a "bundle" of goods and services that a representative group buys or earns. Over time the bundle changes; for example, carriages are replaced with automobiles, and new goods and services are created such as cellular phones and heart transplants.

These considerations do not stop the fascination with these comparisons or even the necessity for them. For example, such comparisons may be critical to determine appropriate levels of compensation in a legal case that has been deferred. The context of the question, however, may lead to a preferable measure and that measure may not be the Consumer Price Index (CPI), which is used far too often without thought to its consequences.

The example below of what Babe Ruth's salary was "worth" can demonstrate this point. His earnings had a "purchasing power" in today's price of a million dollars, but he could not purchase any effective cure for cancer. His income compared to what the average household spends is three million dollars today and yet there were no television sets to buy and if he could there would be nothing to watch.

However, if the question was how to compare his salary with that of a current super star such as Tiger Woods or Barry Bonds, using Ruth's wage compared to an unskilled worker, the average income or the percent of Gross Domestic Product (GDP) he earned gives comparable numbers.

Presented here are six indicators for making such comparisons in US dollars between any two years from 1774 to 2007. They are the CPI, the GDP Deflator, the consumer bundle, the unskilled wage rate, the GDP per capita, and the GDP. Note that only two indicators, the CPI and unskilled wage are available from 1774 to 1790, and the consumer bundle is only available from 1900 to the present.

One or more of the indicators may be most appropriate for you depending on the nature of your query. See below for the definitions of the indicators and some examples.

[B]The CPI is most often used to make comparisons partly because it is the series with which people are most familiar. This series tries to compare the cost of things the average household buys such as food, housing, transportation, medical services, etc. For earlier years, it is the most useful series for comparing the cost of consumer goods and services. It can be interpreted as how much money you would need today to buy an item in the year in question if its price had changed the same percentage as the average price change.[/b]

The GDP Deflator is similar to the CPI in that it is a measure of average prices. The "bundle" of goods and services here includes all things produced in the economy, not just consumer goods and services that are reflected in the CPI.

The Consumer Bundle is the average dollar value of the annual expenditures of a "consumer unit". The consumer unit could be a family or another type of household. The main point is that spending is a joint decision of the members of the unit. The bundle increases over time as household income increases. Unlike the CPI, not only the cost but also the amount of goods and services increases over time. Note, the 2006 value of the consumer bundle will not be published until November 2007.

The Unskilled Wage Rate is good way to determine the relative cost of something in terms of the amount of work it would take to produce, or the relative time it would take to earn its cost. It can also be useful in comparing different wages over time. The unskilled wage is a more consistent measure than the average wage for making comparisons over time.

The GDP per capita is an index of the economy's average output per person and is closely correlated with the average income. It can be useful in comparing different incomes over time.

The GDP is the market value of all goods and services produced in a year. Comparing an expenditure using this measure, tells you how much money in the comparable year would be the same percent of all output.