Consumer Price Index

Consumer price index or CPI is an inflationary indicator, which measures the changes in the average prices of consumer goods and services purchased by the households. In the United States, it was first started in 1919 during the first world war by the Bureau of Labor Statistics (BLS), because of rapidly increasing prices.

The consumer price index is determined by measuring the price of a representative sample group for a commodity bundle of a representative urban consumer, designed by the U.S. Bureau of the Census. It is calculated by many national statistical agencies. The change in the percentage of consumer price index represents inflation. It is an economic indicator, which shows the effectiveness of the country's economic policies.

Purpose of Consumer Price Index
CPI is used by economists and financial consultants as a guide for making economic decisions. CPI helps in adjusting the inflation effects on salaries, wages, pensions, retail sales, components of the national income and product accounts; and also regulated and contracted prices. It helps in determining price changes in the nation's economy, which is useful for governments, businessmen, labor leaders, and private citizens.

How to Calculate CPI
CPI is a measure, that determines the changes in the price for a incessant commodity bundle of goods and services for a particular area, during a particular period. Basically consumer price index is a ratio of the price of the commodity bundle in a particular year to the price in the base year, multiplied by 100. We can also say that, if a person pays $100 in the base year, then CPI is the amount that he has to pay, to buy the same goods in a particular year. It changes as per the month and also as per the area.

CPI= (price of the commodity bundle in a particular year/ price in the base year)*100

(In the United States, the current base period used is 1982-4.) Being a ratio, CPI has no unit. Usually, it is represented in time series. Current consumer price index is generated by the Bureau of Labor Statistics (BLS) for every month. It is calculated for goods including

• Recreation goods
• Drugs and health services
• Clothes and jewelry, transportation goods and services
• Food and beverages (like milk, coffee, chicken, wine, full service meals, snacks)
• Residences (including rent of primary residence, owner's equivalent rent, fuel oil, bedroom furniture)
• Educational and communicational goods and services (for example, college tuition, postage, telephone services, computer software and accessories)

And many other goods and services not listed above. Government user fees and taxes, that are directly associated with purchasing of goods and services such as excise tax and sales tax are included in the consumer price index. CPI prices are changed and reviewed according to the price changes in consumer purchasing habits and demographics or population distribution shifts.

Limitations of Consumer Price Index
Though CPI is a widely used index, it has few limitations. It does not take into account the changes in taxes, health care, consumer safety, crime levels, water quality, air quality, and educational quality. It also sticks to the experiences of people living in the urban area. Psychological behavioral patterns of the buyer are not considered. CPI may not be applied to all population samples. Measures may not be accurate, because of the sampling and non-sampling errors such as substitution bias, quality bias, formula bias etc.

Consumer Price Index is an index, which measures the average price level of the goods and services purchased by a sample in a particular year. Nowadays, personal consumption expenditures price index (PCE) is more preferred by the federal reserve system, because of the limitations of CPI. However, CPI is still a widely used price index to measure inflation and it's effect on economy.