Consumer Price Index (CPI): Everything you want to know

Consumer Price Index is a price index calculated as the average of consumer goods and services that households purchase. The changes observed in the consumer price index help track the fluctuation in prices over some time.

Consumer Price Index is calculated by a basket of goods and services. The consumer spending habits decide and update the representative basket to reflect the changes. They are collected monthly from a sample of retail and service establishments. The prices may be adjusted for changes in quality.

Inflation can be tracked by observing changes in the consumer price index over time and comparing inflation rates between different countries. It is not a perfect measure of inflation or the living cost. However, it is a useful tool for tracking the economy.

An Overview of the Consumer Price Index

Consumer Price Index is a statistical estimate. It is constructed using the prices of certain chosen items whose prices are collected over a period. Sub-indices are computed for different categories and sub-categories of goods and services. These sub-indices are combined all together to produce the overall index, the weights reflect their shares in the total of consumer expenditures covered by the index.

Consumer Price Index is one of several price indices calculated by national statistical agencies. The annual percentage change of CPI is used to track inflation. Consumer Price Index can be used to adjust for the effect of inflation. The real value of wages, salaries, and pensions; to regulate prices, and to deflate monetary magnitudes to show changes in real values. In most countries, the CPI is one of the most closely watched national economic statistics.

The index is usually carried out monthly or quarterly in some countries. Detailed weighting information is unavailable, so indices are computed using an arithmetic or geometric mean of the prices of the sampled products chosen for the representative basket.

Nevertheless, the barcode scanner data usage is making weighting information available even at the most detailed level. These indices hold a comparison between prices every month with prices in the price-reference month. The weights are used to combine them into the higher-level aggregates and then further into the overall index related to the estimated expenditures during the preceding whole year of the consumers covered by the index on the products within its scope.

Thus, the index is a fixed-weight index but rarely true as the weight-reference period of a year and the price-reference period, usually a more recent single month, do not coincide.

Calculation of Consumer Price Index

The BLS divides the value of a specific basket of goods today compared to one year ago:

Annual CPI = Value of basket in current year / Value of basket in the prior year x 100

The basket of goods and services used for calculating CPI includes popular items commonly purchased by Americans. The weight of each component is in proportion to how they are sold. The annual CPI is represented as a whole number, and the figure obtained is often greater than 100considering that the current market prices are appreciating.

Calculation of Inflation Rate

Then, the BLS uses the CPI of the current year and the previous year to calculate the inflation rate.

Inflation Rate = New CPI − Prior CPI / Prior CPI × 100 

The inflation rate can be calculated for both, a given month and an annual period. in both cases, the new and the previous period must be selected. The inflation rate is calculated in percentage and is often positive considering that the current market prices are appreciating.

U.S. Consumer Price Index

It is a family of various consumer price indices which is published monthly. The United States Bureau of Labor Statistics (BLS) is responsible for publishing the CPI. Some of the common indices used are CPI-U and the CPI-W. The CPI-U is the most popularly cited measure of inflation in the United States, on the other hand, the CPI-W is used to index social security benefit payments.

Methodology

The Consumer Price Index is measured monthly based on the price changes of items chosen in a particular basket whose prices are borne by the consumer. The 8 major categories included I’m the CPI average for both goods and services are:

• Food and beverages
• Housing
• Apparel
• Transportation
• Medical care
• Recreation
• Education and communication
• Other goods and services

Consumer Price Indices

Core Consumer Price Index

A Core CPI index excludes goods with high price volatility. This typically includes food and energy, to measure more fundamental inflation that affects broader sets of items. More specifically, food and energy prices are subject to large changes that often fail to persist and do not represent relative price changes.

Chained Consumer Pirce Index for all urban consumers (C-CPI-U)

This type of consumer price index applies to the sa,e target application as in the case of the CPI-U. But in this case, the weights are updated each month allowing the weights to evolve more gracefully according to the people’s consumption patterns. In the case of CPI-U, the weights are changed only in January of even-numbered years which remains the same for the next two years.

Consumer Price Index for the Elderly (CPI-E)

The BLS computed a consumer price index for the elderly in 1982. Since then, this index accounts for the consumption factors of senior citizens. According to the BLS a person or a spouse falls under the elderly category if they are 62 years of age. According to the data, approximately 24 percent of people meet this definition. Individuals falling in this age group consume roughly double the amount of medical care as all consumers in CPI-U or even employees in CPI-W.

Consumer Price Index Categories by weight

Uses of Consumer Price Index

Economic indicator

• It is the most widely used measure of inflation. The consumer price index is an indicator of the good impact of government fiscal as well as monetary policies.
  
  
• Business executives, labor leaders, and other private citizens also make use of the consumer price index as a guide which affects their economic decisions.

Deflator of economic series

• The consumer price index is used to adjust other economic series for price changes as well as to translate these series into inflation-free dollars.

Means for adjusting income payments

• Over 2 million workers tie wages to the CPI. In the United States, the income of almost 80 million people is affected by the index.
  
  
• Changes in the consumer price index also impact the cost of lunches for about 26.7 million children who eat lunch at school.
  
  
• The consumer price index is also used by individuals and some private firms to keep rents, royalties, and child support payments streamlined with the changing prices.
  
  
• It is since 1985 that the consumer price index has been used to adjust the Federal income tax structure to prevent inflation-induced increases in taxes.

Current Scenario of Consumer Price Index

• The hike in rents has pushed US inflation a little further. It is expected that the Federal Reserve will cut down on interest rates in the first of the year.
  
  
• The Labor Department has reported a deliberate surge in prices, the largest in four months.
  
  
• It has been pointed out that not all drivers of inflation last month would go into the calculation of the personal consumption expenditures (PCE) price indexes which is used as a measure by the U.S. central bank to gauge the progress to hit its inflation target of 2%.
  
  
• Inflation is decreasing at a really slow pace which is not enough for officials to ease down the rates.
  
  
• CPI rose 0.3% from the prior month, ticking up from December, while climbing 3.1% on an annual basis, down slightly from December’s 3.4% rate. The core prices gauge which leaves out energy and food remained at a 3.9% growth rate from the prior year.
  
  
• The increase was led by categories that economists and markets were expecting would start to ease, namely shelter costs and other services.
  
  
• Shelter was the single largest contributor to January inflation and items including medical care and transportation services also were responsible for the same.
  

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Divyanshi Krishan