The CPI, or Consumer Price Index, is one of the most prominent metrics used to measure inflation and deflation. It measures the changes in the prices of a representative group of goods and services used by the retail consumers of the country over time. The market basket used to determine the CPI represents the consumer’s retail expenditure within the economy.
The CPI index is one of the most popular indexes that measures retail inflation and is widely used by businesses, policymakers, financial markets, and consumers. It interprets the changes in the purchasing power of a country’s consumers, the value of a country’s currency, and the cost of living. Read on to find out - What is CPI?
What Is the Consumer Price Index (CPI)?
● The Consumer Price Index definition can be understood as a tool that measures the changes in the prices of goods and services consumed by a country’s retail population. It consists of a basket of regularly purchased goods and services and measures the economy’s aggregate price level.
● The Consumer Price Index meaning can be interpreted as a measure of the purchasing power of retail consumers who belong to the country’s demand side.
● The CPI is a macroeconomic indicator used by the central and state governments to measure inflation.
It is an important economic tool used by The Reserve Bank of India (India’s central bank) to maintain price stability and control the money supply.
CPI index calculation takes into account the tendency of consumers to shift from products and services that have become expensive over time. The price data is also adjusted for changes in product features and quality. A unique survey methodology, index weights, and prices sample are used to compute the CPI report.
The CPI includes excise or sales taxes and user fees. However, CPI does not include investments like bonds, stocks, life insurance plans, and income taxes. Read on to know more about CPI meaning.
Presentation of CPI
The monthly CPI publication from the BLS showcases the variation from the previous month for the overall CPI-U and also displays the unadjusted variation year-over-year. The market basket is organized under eight spending categories. The table gives detailed information on price changes for a variety of items along with the key subcategories.
Uses of the Consumer Price Index (CPI)
● Helps in making sound economic decisions: Financial market dealers use the CPI to measure inflation. Consumers and businesses use the CPI to make the right economic decisions. The CPI can be used to measure the effectiveness of a government’s monetary policy. As it measures the purchasing power of consumers, it plays a major role in pay negotiations.
● To serve as a deflator for other economic indicators: The CPI can be used to adjust the components of national income, including hourly earnings and retail sales. Its features can be used to separate fundamental change from that indicating change in prices.
● Facilitates cost of living adjustments (COLAs) for clerical employees receiving Social Security benefits and prevents any increase in income tax brackets due to inflation.
Calculation of CPI
The CPI expresses a percentage change in the present price levels of goods in the market from a period in the past which is called the base year. The Ministry of Statistics maintains the base year, Central Statistics Office (CSO), and Programme Implementation (Mospi). It is shifted periodically, and it was recently changed to 2012 from 2010 w.e.f January 2015.
The representative basket is determined using detailed expenditure data. The government spends a lot of money and time collecting accurate expenditure information from surveys. The market basket is classified into clothing, recreation, food and beverages, housing, medical care, etc. These categories are allotted weights, and the CPI is computed by taking into account 299 items.
The formula to calculate the CPI is as follows:
CPI = (Cost of the representative basket in the current year/ Cost of the representative basket in the base year) * 100%
Limitations of the CPI
● The CPI doesn’t cover the entire population group. For instance, CPI-U applies only to the urban population and doesn’t include rural areas.
● The CPI does not consider all the aspects that impact living standards while measuring the cost of living.
● There can be no comparison between the two areas. For example, if one area has a higher index than the other area, it cannot be concluded that the prices are higher in that particular area.
● The CPI methodology has been criticized for either understating or overstating inflation. As it is based on consumer expenditure, it doesn’t consider 3rd party compensation for healthcare which is a significant part of the GDP.
People experience an increase in the price levels of various items every day. Everything is becoming more expensive, from groceries, and IT services, to investments in mutual funds, stocks, etc. There has been a rise in the value of money over the years. A consumer, trader, farmer, businessman, investor, etc., can use the CPI metric, which determines the value of money and fixes the base for all transactions.