### INTRODUCTION

In 1931, Babe Ruth made \$80,000 per year. Was the Great Bambino overpaid or underpaid according to today's standards? The average MLB player today earns \$2,272,620 per year. This lesson will provide you with tools for answering this question.

Determine whether Babe Ruth was overpaid or underpaid in comparison to today's MLB players. This question can be answered by using the Consumer Price Index (CPI) to adjust Ruth's salary for changes in the price level since 1931.

### PROCESS

The CPI can be used to compare dollar figures from different times accurately. You may have heard your grandparents telling you that they remember when a gallon of gas cost a quarter or a loaf of bread was a dime. But those numbers by themselves don't tell us how expensive things were in the old days compared to now. It's the same with salary figures from the past.

For example, in 1931 when Babe Ruth had a batting average of .373 with 46 home runs and 163 RBI's, an ice-cream cone cost five cents and going to a movie in a theater cost a quarter. Ruth's salary then was \$80,000 per year. But, it is not clear from that salary figure alone whether Ruth enjoyed better or worse purchasing power than today's players.

In order to investigate this question, a couple of concepts from economics must be introduced. First, the inflation rate: It is the percentage of increase in the price level of the economy as measured by the CPI. The CPI tracks the overall price change for a fixed basket of goods and services bought by a typical working-class urban family over time. It is a measure of price changes in consumer goods--also known as the "cost of living index." The CPI "basket" contains goods and services that have been chosen for the CPI survey. Imagine a shopping basket loaded up with fruit, chocolate, meat, chips and other items from each of the nine groups of goods and services used in the CPI . The items in the basket must be identical in quantity and quality over a period of time. Some changes in prices may be due to increased quality or improved packaging, but these are not "pure" price changes. When this happens, price adjustments are made to remove the effect of these changes.

We can also distinguish between current dollars and constant dollars. The value of the income (or purchase) at the time it was actually earned (or spent) is measured in current dollars. Current dollars are dollars from other time periods converted into present-day dollars, in order to factor out the effects of inflation. Adjusting a current dollar figure to show the impact of inflation on the purchasing power converts the figure into constant dollars. Constant dollars eliminate the changes in the purchasing power of the dollar over time. The result is a series as it would exist if the dollar had a purchasing power equal to its purchasing power in the base year. For example, it is more useful to compare the change in annual wages measured in constant dollars than in current dollars because of the effect of inflation on purchasing power. While wages in current dollars may have risen over the years, wages in constant dollars may have declined because prices of goods and services that workers bought rose more than wages.

Given all of this, how do we actually make the comparison? Well, this is done using the following formula:

Salary in Constant Dollars (Recent Year)
= Salary in Current Dollars (Old Year)*(CPI in Recent Year/CPI in Old Year)

Using data on the CPI from Minnesota's Federal Reserve Bank web page, determine what Ruth's constant dollar salary was. Was it higher or lower than the average salary of MLB players today? Was Ruth overpaid or underpaid?

### CONCLUSION

Changes in inflation occur naturally with the passage of time. The CPI gives economists a tool they can use to compare dollar amounts of the past to dollar amounts of today.

This lesson introduces you to the idea of inflation and the CPI. It helps you learn how to adjust dollar figures from previous times and compare them to dollar figures today by using a formula or by using the inflation calculator.

### ASSESSMENT ACTIVITY

President Hoover made \$75,000 per year in 1931. President Bush earned \$400,000 in 2005. Who earned more in constant or 2005 dollars?

### EXTENSION ACTIVITY

Choose a dollar amount and a year. Then, using the Inflation Calculator , see how much that dollar amount is worth in today's dollars.

Fill in the following activity using, the formula [Salary in Constant Dollars (Recent Year) = Salary in Current Dollars (Old Year)*(CPI in Recent Year/CPI in Old Year)], CPI data and the CPI Inflation Calculator.

1. President Truman made \$100,000 in 1949, today President Bush makes \$400,000.  How much would President Truman's salary be in 2005?

2. Legendary Colts quarterback, Johnny Unitas, made \$7,000 in 1956.  Is this more than the \$535,000 current quarterback, Peyton Manning makes?

3. Lyndon Johnson made \$200,000 as President in 1969.  Would this be more than President Bush's salary of \$400,000?

4. Michael Jordan made \$33,140,000 during the 1997-98 season.  How much would this be in 2005 dollars?