Consumer Price Index

Consumer Price Index

The Consumer Price Index (CPI) provides a standardized method for comparing the average level of prices faced by the consumers and households of a nation over time. Price-level information is vital to a wide range of personal, government, and business decision makers. The CPI focuses solely on the prices faced by consumers and does not attempt to reflect prices faced by all buying entities in a country. Nevertheless, it is the most commonly used price-level indicator in a nation. It is the basis for the calculation of a country's inflation rate.

COMPUTATION

The Bureau of Labor Statistics (BLS) publishes CPI data monthly. BLS workers collect price data on a set market basket of goods and services in selected cities across the country each month. The market basket includes hundreds of goods and services typically purchased by consumers. The price data is then weighted to represent the mix of goods and services typically purchased by consumers. The mix of goods and services and the weights are based on the Consumer Expenditure Survey, a national survey of the spending habits of 29,000 families (BLS, "How BLS Measures"). The decennial census of the population is used for selection of the urban areas included in the monthly surveys.

The CPI is computed by dividing the weighted price of the market basket in a time period by the weighted price of the market basket in a designated base time period. The resulting ratio times 100 yields an index with a value of 100 for the base time period. CPI values above or below 100 indicate that the price level is higher or lower than it was during the base period. For example, an index value of 140 indicates that the average price level is 40 percent higher than it was in the base year.

The prices of hundreds of goods and services are surveyed each month. The goods and services are organized into eight main groups: food and beverage, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services.

Each month the BLS publishes numerous CPIs based on the data collected. The two main CPI series are the CPI-U (Consumer Price Index for All Urban Consumers) and the CPI-W (Consumer Price Index for Urban Wage Earners and Clerical Workers) Separate indices are published for twenty-six selected urban areas and four geographic regions of the country. There are also indices for three classes of cities (population of over 1.5 million, mid-sized to small metropolitan areas, and nonmetropolitan areas) and for categories of goods and services.

MEASUREMENT ISSUES

The CPI provides a general approximation of the price level faced by consumers in a given time period. It is not designed to measure the exact price level faced by any one consumer. The BLS collects data only in urban areas. Thus the CPI does not attempt to provide a measure of rural price levels. However, the CPI-U should be serviceable for approximately 87 percent of the U.S. population (BLS, "Guide to Available.") A two-week lag time exists between the completion of data collection and the publication of CPI data. The measure has limitations. The computational methodology has been gradually adjusted over time to allow for more accurate measurement of changing price levels. Measurement issues include index bias due to product innovation and quality changes that affect prices and consumption patterns, as well as uneven price changes across retail outlets and geographic areas.

Historically, the CPI has been calculated as a Laspeyres index, or an index based on a fixed market basket of goods and services. This has been criticized as an inaccurate approach because it does not allow for changing consumption patterns. Consumption patterns may change due to the availability of new products, changing features of current products, changing consumer preferences, or changes in the relative prices of goods and services. The impact of the availability of new products on purchasing patterns is exemplified by products such as videocassette recorders and microwave ovens, which were not available for consumer purchase until the late 1970s but became common household purchases in less than a decade. The emergence of audio CDs and CD players reduced purchases of audio-cassette tapes.

Price changes due to changes in product quality or features can be seen in the development of the manual typewriter, electric typewriter, and word processor. Adjustments are made in the computation of the CPI for the impact of quality changes on price. Also, periodic adjustments in the market basket have been made every eight to twelve years to allow for changing consumption patterns due to new products. This creates a situation in which price-level comparisons may be more accurate when made over relatively short periods of time rather than over many years or decades during which the nature and mix of goods and services in the market basket changed considerably. The base year is also changed periodically. For example, in January 1988 the CPI base year was changed from 1967 100 to 1982-1984 100.

Beginning with January 1999 data, the BLS changed to a geometric-mean-estimator method of indexing. This method does not employ the Laspeyres fixed market basket; rather, it allows consumers to adjust purchases within broad categories of goods and services due to changes in the relative prices of the goods or services within each category. The consensus of experts was that the Laspeyres method led to a CPI which systematically overestimated the price level actually paid by consumers, because consumers would substitute away from goods that increased in price in favor of similar goods with lower increases in price. The geometric-mean-estimator method was adopted to reduce this overestimation. As part of this change, the BLS reports that CPI expenditure weights are to be updated on a regular two-year schedule (BLS, "Future Schedule").

During a year the prices of many goods