Consumer Price Index (CPI) Definitions, Types and Formulas

The consumer price index is a measurement used to measure the average change in price over a while. It uses a market basket of consumer goods and services, including food items, services, etc. It measures consumer inflation and is the most appreciated method for understanding the economy.

1. The Bureau of Labour Statistics calculates the CPI.
2. CPI is mainly calculated to analyze the impact of price changes on the cost of living of the average consumer.
3. Policymakers, business houses, financial markets, and consumers use the CPI.
4. Around 93% of the US population is covered by the CPI. 

Consumer Price Index Formulas in Simple Way

The Bureau of Labour Statistics surveys around 80,000 items every month. They contact retailers, service providers, and rental spaces to collect information.

CPI is calculated using a formula.

CPI = Cost of the Market Price in a Given Year / Cost of the Market Basket in Base Year* 100%

1. The baseline from 1982–1984 is used to measure the CPI.
2. The index is set at 100 to serve as a reference point.
3. CPI at 110 indicates that the prices rose by 10% compared to the baseline. Likewise, the CPI at 90 indicates that the price dropped by 10% compared to the baseline.

What are the types of Consumer Price Indexes?

The Bureau of Labour Statistics publishes four types of consumer price indices.

CPI-U: For all urban consumers

• The Consumer Price Index for All Urban Consumers measures the change in price over a period of time. 
• Urban areas include cities or towns with at least 10,000 people.
• It also includes places near big cities.
• CPI-U covers 93% of the US population.

CPI-W: For Urban Wage Earners and Clerical Workers

• The CPI-W measures the price change of those things that wage earners and clerical workers mainly use.
• It is important to analyze the Social Security benefits and the changes that must be made due to rising inflation.
• It covers more than 200 goods and service items.

CPI-E: For the Elderly

1. CPI-E measures the price change specifically for elderly people.
2. It focuses on people 62 years and older and where they spend money.
3. It is measured for official use by the government to provide benefits to the elderly population.

C-CPI-U: For All Urban Consumers

• The chained consumer price index for all urban consumers determines when people switch to different items when the price changes.
• It helps to understand how the consumer adapts according to price changes.
• It gives more accurate analyses of how inflation affects people's daily lives.

How is the CPI used?

CPI is used by financial markets, government organizations, and business houses to make economic decisions.
It helps to understand the change in the purchasing power of the consumer.

1. Federal Reserve

• The Federal Reserve uses the CPI to make economic decisions. It aims to keep inflation around 2%.
• It helps them determine monetary policy to keep the economy on track.

2. Government Agencies 

The CPI helps to understand how inflation impacts the consumer; therefore, it helps government agencies determine whether the consumer needs benefits from Social Security. If yes, how much?

3. Landlords 

Landlords use CPI to determine the rise in rent each year. It helps to increase the rent reasonably.

4. Financial Market

CPI drives the financial market. The CPI determines the bank rates, Fed policies, etc., directly impacting the market.

Is high CPI good or not?

A lower CPI is a sign of low inflation. It also implies stability in the market, as the prices are stable. The low inflation period increases the buying power of the consumer. On the other hand, a higher CPI is a sign of high inflation, which decreases the consumer's buying power.

How does CPI affect inflation?

The changes in CPI directly imply changes in inflation. If the CPI changes upward, the cost of living is increasing. You are spending more on the same item you purchased previously. Likewise, if CPI decreases, the cost of living is in your favor.

How much CPI is good?

Most people assume that low CPI is good for the consumer as it is a sign of deflation, but it should be noted that extreme negative and positive CPI can harm the economy in many ways. A slow increase or decrease in CPI is a sign of a healthy economy, while sudden and rapid changes can badly impact the economy.

Final words

The consumer price index is an important measurement to determine the health of an economy. It measures the changes in prices of goods and services over a certain period and their impacts on the consumer. It also helps to determine the economic policies of the government. The Bureau of Labour Statistics measures CPI. 

Read Also:

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2. Capital Adequacy Ratio

3. Debt to Income Ratio