Consumer price index

M2, CPI, PCE

CPI 1914-2022

Inflation compared to federal funds rate

US Consumer Price Index Graph

Inflation data

Consumer Price Index (CPI) is an economic indicator that measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. It is one of the most closely watched national economic statistics, as it is used as an indicator of inflation, as a deflator of other economic series, and as a means for adjusting dollar values.

Overview

The CPI measures inflation as experienced by consumers in their day-to-day living expenses. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living. The CPI is a fixed quantity price index and considers only the prices of the goods and services purchased by consumers.

Calculation

The calculation of the CPI involves several steps. First, a base year is chosen. The total cost of the basket of goods and services at the base year prices is then compared to the total cost of the same basket at current prices. The formula used to calculate the CPI is:

\[ \text{CPI} = \left( \frac{\text{Cost of basket in current year}}{\text{Cost of basket in base year}} \right) \times 100 \]

Uses

The CPI is used for three main purposes: 1. As an Economic Indicator: It provides a clear view of the inflationary trends in the economy. 2. As a Deflator: It is used to deflate or adjust other economic series for price changes, allowing comparisons in real terms over time. 3. For Cost of Living Adjustments: Contracts and salaries often include cost of living adjustments (COLAs) based on changes in the CPI.

Types of CPI

There are two main types of Consumer Price Index: 1. CPI for Urban Wage Earners and Clerical Workers (CPI-W): It covers households of wage earners and clerical workers. 2. CPI for All Urban Consumers (CPI-U): It covers approximately 88% of the total population, including professionals, the self-employed, the poor, the unemployed, and retired people, as well as urban wage earners and clerical workers.

Criticisms and Limitations

The CPI has been subject to criticism for several reasons. Some argue that it does not accurately reflect the true cost of living increases due to the substitution effect, changes in retailing, introduction of new products, and quality changes of goods and services. Additionally, the CPI cannot be used to compare the cost of living across different geographic areas due to regional price differences.

Conclusion

Despite its limitations, the Consumer Price Index remains a crucial tool for economic policy, business planning, and personal finance decisions. It plays a vital role in understanding inflation and guiding economic policy.