Constant Dollar Definition
What is a Constant Dollar?
A constant dollar is an adjusted value of currency used to compare dollar values from one period to another. Due to inflation, the purchasing power of the dollar changes over time, so in order to compare dollar values from one year to another, they need to be converted from nominal (current) dollar values to constant dollar values. Constant dollar value may also be referred to as real dollar value.
Constant dollar calculation:
Second Year Constant Dollar Value
=
FYDV
×
CPI
2
CPI
1
where:
FYDV
=
First year dollar value
CPI
2
=
Consumer price index for second year
CPI
1
=
Consumer price index for first year
begin{aligned} &text{Second Year Constant Dollar Value} = text{FYDV} times frac { text{CPI}_2 }{ text{CPI}_1 } \ &textbf{where:} \ &text{FYDV} = text{First year dollar value} \ &text{CPI}_2 = text{Consumer price index for second year} \ &text{CPI}_1 = text{Consumer price index for first year} \ end{aligned}Second Year Constant Dollar Value=FYDV×CPI1CPI2where:FYDV=First year dollar valueCPI2=Consumer price index for second yearCPI1=Consumer price index for first year
Basics of Constant Dollars
The constant dollar is often used by companies to compare their recent performance to past performance. Governments also use the constant dollar to track changes in economic indicatorssuch as wages or GDP. Any kind of financial data represented in dollar terms can be converted into constant dollars by using the consumer price index (CPI) from the relevant years.
Individuals can also use constant dollars to measure the true appreciation of their investments. For example, When calculated in the same currency, the only instance when a constant dollar value is higher in the past than the present is when a country has experienced deflation over that period.
Key Takeaways
- Constant dollar is an adjusted value of currencies to compare dollar values from one period to another.
- Constant dollar can be used for multiple calculations. For example, it can be used to calculate growth in economic indicators, such as GDP. It is also used in company financial statements to compare recent performance to past performance.
Example of Constant Dollars
Constant dollars can be used to calculate what $20,000 earned in 1995 would be equal to in 2005. The CPIs for the two years are 152.4 and 195.3, respectively. The value of $20,000 in 1995 would be equal to $25,629.92 in 2005. This is calculated as $20,000 x (195.3/152.4). The calculation can also be done backwards by reversing the numerator and denominator. Doing so reveals that $20,000 in 2005 was equivalent to only $15,606.76 in 1995.
Suppose Eric bought a house in 1992 for $200,000 and sold it in 2012 for $230,000. After paying his real estate agent a 6% commission, he’s left with $216,200. Looking at the nominal dollar figures, it appears that Eric has made $16,200. But what happens when we adjust the $200,000 purchase price to 2012 dollars? By using a CPI inflation calculator, we learn that the purchase price of $200,000 in 1992 is the equivalent of $327,290 in 2012. By comparing the constant dollar figures, we discover that Eric has essentially lost $111,090 on the sale of his home.