What Is Consumer Price Index (CPI)?

The Consumer Price Index which is can also be known as CPI is the magnitude of the total amount of expenditures in an economy. It is an estimated average mean of changes in the prices of the goods or the products over time.

Consumer Price Index is generally used as a monetary index. CPI is also used as the method to calculate the hike in the prices and to check the efficiency & effectiveness of the government’s budget policy.

The CPI is the method through which the average price of the services and goods like a living, food, medical care, and transportation is calculated and then examined.

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Understanding the Consumer Price Index

The CPI is calculated to determine the mean price change for the commonly used goods or services. If the consumer price index is more than 100 then it is termed as the inflation and if the value of the consumer price index is estimated below 100 then it is termed as deflation.

Since 1913 the United States Bureau of Labor Statistics measures the CPI value every month. So if the value of CPI is 100 then this means that there is neither inflation nor deflation has occurred.

For calculating Consumer Price Index the things which are included are:

  1. Changes in the prices of retail goods.
  2. Changes in transportation prices.
  3. Price change in medicines.
  4. It also includes the amount which is paid in either way by the consumer to take any services or to purchase any type of goods.

The expenditure or price changes which are not included for calculating the CPI are:

  1. It does not include the savings of any individual, group, or body.
  2. It also does not include the amount which is spent by foreign nationals while visiting the country.

What & Who Comes Under CPI

To calculate the Consumer Price Index more precisely, we include the expenditures which are made by the consumers, to fulfill their basic needs.

The people whose consumption matters most or the people who are covered to calculate this mean are:

  1. Professionals like a doctor, engineer, lawyer, etc.
  2. Self-employed like businessmen, freelancers, or the people who work on daily, temporary, or on a project basis.
  3. Unemployed people.
  4. Retired people.

People whose consumption is not included to calculate the Consumer Price Index are:

  1. People who are living in rural areas.
  2. The people who are in the armed forces or serving the nation.
  3. The consumption made by the families who are dependent on farming for their source of consumption or earning.
  4. The consumption made by prisoners is also not included.
  5. Mentally retarded people who are admitted to the mental hospital.

Consumer Price Index is the representation of the amount which is spent by the whole country to purchase the products or for taking certain services.

These products and services which are included to calculate the CPI, are again divided into 8 broad categories. These categories are:

  1. Apparel.
  2. Education & communication.
  3. Food and Beverages.
  4. Housing.
  5. Medical Care.
  6. Other Goods and Services.
  7. Recreation.
  8. Transportation.

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How CPI is Calculated

The Bureau of Labor Statistics is calculated by estimating the mean expenditure which is made by the citizens of the country to take any services or to purchase any products.

To calculate the correct CPI, BLS monitors every mall, shop, or the various service providers that are near to the figure of 80,000 bodies. The CPI for every other item is calculated individually or separately.

To calculate CPI the base year needs to be decided, and the base year is decided by the Bureau of Labor Statistics.

The formula which is used to calculate the Consumer Price Index for a single item is:

CPI= (Cost of the Market Basket in Given Year/ Cost of the Market Basket in the Base Year)* 100

This is the only formula that is used to calculate the CPI.

Types of CPI

2 different types of CPI’s are calculated every time. These are:

CPI-W

CPI-W is used to calculate the Consumer Price Index for Urban Wage Earners and Clerical Workers. CPI-W mainly calculates the difference in the cost of the benefits which can be paid through social security. The CPI-W exhibit the expenditure of a minimum of 28% of the country’s population.

CPI-U

CPI-U can be expanded as Consumer Price Index for Urban Consumers and it is calculated on the consumption of metropolitan. This represents almost 88% of the country’s population. It includes professionals, self-employed people, clerical workers, wage earners, unemployed, retired, and the people who come under BPL. It includes the majority of the population.

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Uses of CPI

Consumer Price Index is used basically to calculate and maintain the country’s economy. CPI is broadly used as:

  1. It is used as Economic Indicator: Consumer Price Index calculates the hike in prices which are paid by the consumers and the effect of it on the consumption. If the CPI is increasing regularly then it is considered as the economic growth of the country. It also showcases the effectiveness of the government’s budget policy.
  2. Elements of a country’s income and other economically important elements can be adjusted according to CPI.
  3. To calculate and adjust the normal living expenditure and social security benefits. It is done to restrict the hike in the tax rates.

Limitations of CPI

  1. CPI does not apply to the overall population of the country.
  2. It does not include every group which is responsible to maintain the standard of living.
  3. Social and environmental factors are also not included.
  4. The average is calculated through CPI. However, 2 different areas cannot be kept in comparison.

Limitations for Measuring CPI

There are possible errors that can be encountered while calculating the Consumer Price Index. These are broadly classified into 3 broad groups:

  1. The most important possible reason for calculating or estimating the incorrect CPI is that whether the correct mass of the population is chosen.
  2. Errors or the incorrect CPI which is calculated or caused due to improper execution of the procedures.
  3. One of the major drawbacks is that while calculating the CPI the energy cost is not included, however, it is one of the elements which demands a handsome amount and is used by everyone.

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