All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

Adjustments for Inflation

How much are wages increasing? How much of a wage increase do I need to give my workers so that they are not falling behind the wages of other workers?   When is a wage increase not a wage increase?  When are sales increases actually not increases?  How can a 10 percent increase in sales actually be a loss? How can interest rates actually be negative so that people are paying you to borrow money?   These are only a few questions you may find yourself confronting at some point. The common denominator in all of these questions is they involve interpretations of financial data that have a price component, and the data must be adjusted for changes in the price level?

As an example we can look at the question: Has the state been supportive of higher education over the past 16 years? This is both an important question to all those enrolled at the school, as well as a perfect question to use as an example for constructing and interpreting inflation adjusted data. We can begin with state appropriations, the money that the state contributes to its institutions of higher education. Below you will find a table of state appropriations to higher education. What can you tell about state support given these data?

State Appropriations

It turns out that these data are of limited value. While it is true that state appropriations have risen nearly $50,000,000 over this period, this turns out to be a highly flawed measure of the state support. The problem is that during this time, prices were rising which was reducing the buying power of the appropriations. Unless we use some adjustment for changing prices, there is no way to compare the dollar figures from different years.  This is one of the most important uses of price level data. 

The formula used for adjusting any data for inflation looks very much like the formula linking real and nominal GDP. The relationship between the nominal / actual value (N) and the real / inflation adjusted value is:

R = N/PI *100

• R = real value (constant dollar)
• N = nominal value (current dollar)
• PI = price index

Note: There is one small addition if you want to get things in current year dollars. You need to take the real figure for any year and multiply it by the price index for the current year. You will know that you got it right if the nominal value and the real values are the same for the current year.

As you expected, the situation looks very different from what we saw with the unadjusted data. Rather than increasing since 1980, state appropriations have actually been declining. In 1996, state appropriations to higher education are approximately $9,000,000 lower than they were in 1980.

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