This lesson demonstrates a method for teaching students about inflation and the Consumer Price Index, using baseball players’ salaries for purposes of illustration. Babe Ruth’s salary from 1931 is adjusted to account for changes in the price level and is then compared to the salaries of those playing major league baseball players today.
In 1931, Babe Ruth made $80,000 per year. Was the Great Bambino overpaid or underpaid according to today’s standards? On average, Major League Baseball (MLB) players today earn $2,272,620 per year. This lesson will provide you with tools for answering this question. [Explain to the students that prices have also risen over this time period making this question more complicated than it appears.] 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.
- Use the consumer price index (CPI).
- Understand that changes in the rate of inflation relative to changes in earnings can improve or worsen purchasing power.
- Understand that constant dollar figures are more useful for making comparisons than current dollar figures.
CPI: US City Average Chart: This chart provides data CPI December 2005.
USA Today: This site presents data on salaries for today's MLB players
What is a Dollar Worth?:This site provides an inflation calculator
What is a Dollar Worth: This site contains information regarding Consumer Price Index (CPI) data
This is a calculator that can be used for any math problem.
The Consumer Price Index (CPI) can be used to compare dollar figures from different times accurately. The students may have heard their grandparents telling them that they remember when a gallon of gas cost a quarter or a loaf of bread cost 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 RBIs, 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 time, 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 a simple formula as follows:
Note: * = multiplication
Salary in Constant Dollars (Recent Year) = Salary in Current Dollars (Old Year)*(CPI in Recent Year/CPI in Old Year)
[Using data on the consumer price index from the web page above we can determine what Ruth’s constant dollar salary was as follows:
Ruth salary in 2005 Constant Dollars= Ruth Salary in 1931 Current Dollars * (CPI in 2005/CPI in 1931)
$1,027,895 = $80,000 * (195.3/15.2)
[Ruth’s salary in constant 2005 dollars was about $1 million per year. This is clearly lower than even the average baseball player makes today, and much less than the stars make (Alex Rodriguez of the New York Yankees is the highest-paid MLB Player at $22 million per year). In 2005, 426 MLB players made the same as or more than the great Babe Ruth.]
This lesson introduces the idea of inflation and the consumer price index. Students 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.
Show the students this Inflation Calculator from the Federal Reserve Bank of Minneapolis.
Have the students choose a dollar amount and year: the calculator will determine what that dollar amount is worth in today's dollars.
Have the students 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.
President Truman made $100,000 in 1949, today President Bush makes $400,000. How much would President Truman's salary be in 2005? [President Truman's salary would be $817,647.05 in 2005.]
Legendary Colts quarterback, Johnny Unitas, made $7,000 in 1956. Is this more than the $535,000 current quarterback, Peyton Manning makes? [Johnny Unitas' salary would be $50,080.88, which is not more than Peyton Manning's.]
Lyndon Johnson made $200,000 as President in 1969. Would this be more than President Bush's salary of $400,000? [Lyndon Johnson's salary would be $1,060,490, which is much more than President Bush's today.]
- Michael Jordan made $33,140,000 during the 1997-98 season. How much would this be in 2005 dollars? [Jordan would be making $40,180,959.50 in 2005 dollars.]
[Answers may vary slightly due to rounding.]
President Hoover made $75,000 per year in 1931. President Bush earned $400,000 in 2005. Who earned more in constant or 2005 dollars?
[$963,651 = $75,000 * (195.3/15.2)
Hoover was paid significantly more than Bush when changes in the price level are considered.]