Consumer Price Index
Defining consumer price index
Consumer price index can be defined as a measure that evaluates or examines the weighted average of the prices of consumer goods and services in a basket. This may include food, medical care, housing, recreation, education and communication, apparel and transportation. CPI is calculated by taking changes in price for each item in a basket of goods that is preset and averaging them. The goods are weighted based on their significance.
Changes in CPI are further used to analyze prices changes that are closely associated to the cost of living, otherwise known as headline inflation. It does not include investment products or items such as bonds, real estate, and life insurance and stocks because these items only relate to savings and not in any way related to day to day consumption expenses.
Every month, state economists at the Bureau of Labor Statistics in the US, labor department release latest Consumer Price Index data. This is usually a measure of average change over a given period of time and in the price paid by many urban households for a set of consumer items and services.
Expenditure items for the households are classified into different categories arranged into 8 different good. The change in the percentage in CPI offers a measure of inflation.
Specific applications of Consumer Price Index
There are a number of consumer price index applications and they include
-Escalating the dollar value over a specific period of time and to maintain the purchasing power of that value. Over the past years, it has been widely used to adjust wages, rents, child or spousal support, leases and other contracted payments. Public and private pension plans, personal income deductions and other state social payments are also escalated using the indicator.
It is also used an economic aggregates deflator either of income flows to generate estimate income of constant dollar or of expenditure flows, to generate personal expenditure estimates at a stable price.
Additionally, the indicator is used to set and monitor economic policy implementation. For example, the Bank of Canada uses the indicator and its special aggregates to closely monitor its monetary policies.
Economists and business analysts also use the indicator for economic analysis and research on different issues for example causes and effects of inflation and to understand regional differences in regards to price movements
It is imperative to note that price movements of different goods and services represented in CPI are weighed depending on the significance of goods and services in total consumer expenditure. Each good or service is therefore seen as an element in a basket that is representative of consumer spending.
Price movements are also assigned a basket share with total consumption expenditure proportion they are responsible for. Therefore it reflects spending patterns of population groups including all urban consumer, clerical workers and urban wage earners (the self-employed, unemployed, professionals and poor people). All urban groups represent about 87 percent of US population.
All urban consumer group price change is as a result measured by traditional Consumer Price Index for all urban consumers. While it is in some cases referred to as a cost of living index, CPI is one of the best and effective lagging indicators but is quite different in a number of ways from complete index. This is because it does not take into account a change in other factors affecting the well-being of a consumer. Therefore, it is and can be difficult to quantify especially when it comes to health, quality of water, safety and crime.
Similarly, alternative price indices lead to different important conclusions in regards to price changes over a long period of time. The changes and differences affect conclusions in regards to time trends, more specifically on low income families or those below the poverty line.
Limitations of CPI
Despite the fact that CPI is one of the best indicators, it also has its limitations including limitation in measurement. This can be grouped into two major types, non-sampling errors which occurs from different sources and sampling errors due to the fact that CPI measures changes in price based on a sample of goods.