The Consumer Price Index

I’m sure you have heard the term ’Consumer Price Index,’ or seen written about it (abbreviated as CPI). But what is it? How does it affect us?

What is It?

The Consumer Price Index is a measure of the price paid for a basket of goods and services that an average urban consumer or household might want to purchase.It’s probably the most important indicator of inflation or deflation. The number is computed monthly and published by the U.S. Bureau of Labor Statistics. This index has been calculated every year since 1913. The number is an amalgamation of many, thousands, of specialty indices.For example, the CPI includes a sub-index for ’food’ and ’food away from home’, one for ’energy,’ which itself is broken down into ’gasoline’, ’fuel oil’, ’electricity’, ’gas’.There is one for ’medical care services’ and one for ’shelter’. In other words, there are numbers for almost everything that we, as consumers, might want to buy as part of our daily living. The CPI is computed by a weighted sum of all of the sub-CPIs, the weights depending generally on what fraction of the market the product of the sub-CPI is holding.

The basic information for calculating the CPI is collected from interviews with thousands of families across the country about their spending habits an experiences that are recorded in diaries. The goods and services used by these families are filed in over 200 categories which are partitioned into eight groups: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. In addition, prices of goods and services are collected monthly from thousands of businesses.

The CPI is calculated for two population groups: All Urban Consumers (CPI-U) and Urban Wage Earners and Clerical Workers (CPI-W). The CPI-U represents about 87 percent of the total U.S. population and is based on the expenditures of all families living in urban areas. Another important set published is called the "CPI-U for All Items Less Food and Energy". Economists consider the latter one as the ’core’ number because they feel that food and energy are too volatile and too unpredictable.

Note the the content of the basket of goods and services is constantly changing because items on the market are constantly changing. Hence, there is a great deal of analysis and statistical juggling that goes on before the numbers are published. Much of this is done in cooperation with other countries.

The change in these numbers from month to month provides in indication of cost increases or decreases, and hence provides a measure for inflation.

The first graph below shows the CPI for every month of the year from Jan 1998 to Dec 2009. The baseline value of 100 was set in Jan 1983 when a number of changes were incorporated in the calculation of the CPI. Hence the graph shows how prices have increased over time. Similar charts could be produced for each of the sub-indices.

The second graph shows the ’rate of change’ of the CPI-U and the ’rate of change’ of the ’core’ index mentioned above. You may notice how much smoother this latter index behaves.

How Does It Affect Us?

The CPI affects you in many ways. Certain kinds of legislation mandates the use of the CPI, such as, for example, in establishing annual increases in social security benefits. In the private sector, the CPI is most frequently used in collective bargaining agreements, rental contracts, insurance policies with automatic inflation protection, and alimony and child support payments.

Author: Pete Versteegen - Ridgeview Valley, LLC

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The Consumer Price Index

What is It?

How Does It Affect Us?

Further Reading