Consumer Price Index (CPI)

The Consumer Price Index (CPI), sometimes called the cost-of-living index, measures the average change in prices that typical American wage earners pay for basic goods and services, such as food, clothing, shelter, transportation, and medical care. It is expressed as a percentage of the cost of the same goods and services in a base period. For example, using the years 1982 to 1984 as a base period with a value of 100, the CPI for December 2005 was 198.6, meaning that prices had increased by an average of 98.6 percent over time. The CPI is often used to measure inflation, so it is closely monitored by government policymakers and by individuals whose wages vary with the purchasing power of money. The practice of indexing wages to the CPI is known as a cost-of-living adjustment (COLA). The term "cost of living" is often applied to the numerical result of the CPI. Loosely defined, it refers to the average cost to an individual of purchasing the various goods and services needed to maintain a reasonable living standard.

The U.S. Bureau of Labor Statistics (BLS) began calculating the CPI in 1917, and over the years it has become an important economic statistic. The CPI is calculated monthly and is usually reported within the first two weeks of the following month. In order to calculate the CPI, the BLS surveys about 24,000 households to find out where families shop regularly and what types of goods and services they purchase. It then contacts about 21,000 retail businesses in 85 major metropolitan areas to obtain prices for 90,000 items. All of this information is combined in the CPI, which represents the average price of a "market basket" of goods and services.

The selection of items in the basket can not be held absolutely fixed for a very long period, of course, since the mix of items people buy changes over time. For example, the weight on tobacco in the CPI basket has fallen over the years as the number of smokers in the population has fallen. Personal computers were not part of the CPI in the 1970s but are a part of the basket today. To address these changes in purchasing patterns the BLS tries to incorporate any new developments in the market by changing 20 percent of the retail outlets and items in its survey every year on a rotating basis.

A separate CPI is calculated for different income levels, geographical areas, and types of goods and services. For example, the CPI-U is calculated for all urban households, which includes about 80 percent of the U.S. population. In contrast, the CPI-W measures average price increases for the 32 percent of Americans who derive their primary income as wage earners or clerical workers. The BLS also publishes a CPI for each of seven major categories of items: food and beverages, housing, apparel, transportation, medical care, entertainment, and other goods and services. In addition, it compiles individual indexes for 200 different items and combined indexes for 120 smaller categories of items. Separate CPI measurements are also released for four major geographical regions of the United States—Northeast, North Central, South, and West—as well as 29 large metropolitan areas.

The CPI influences the American economy in several ways. A high annual percentage increase in the CPI reflects a high rate of inflation. The Federal Reserve Board, which controls the nation's money supply, often reacts to such increases by raising interest rates. This makes it more expensive for individuals and businesses to borrow money, which usually slows spending, encourages saving, and helps to curb inflation in the economy. The CPI also determines the percentage of annual increase or decrease in income for many Americans. For example, COLA formulas based on the CPI are built into many employment contracts. The federal government also uses the CPI to adjust Social Security and disability benefits, to determine the income level at which people become eligible for assistance, and to establish tax brackets. In addition, the CPI is often used to compare prices for certain goods within a set of years, and to calculate constant dollar values for two points in time.

Some economists believe that the CPI overstates actual increases in the cost of living by 1 percent or more annually. They generally attribute the discrepancy to some combination of the following four factors: improvements in the quality of goods; the introduction of new goods; substitution by consumers of different goods or retail outlets; and the difficulty of measuring the prices consumers actually pay for goods.

BIBLIOGRAPHY

Boskin, Michael J. "The CPI Commission." Business Economics. April 1997.

"Cost-of-Living Lesson." American Demographics. December 1994.

Reinsdorf, Marshall. "The Effect of Price Dispersion on Cost of Living Indexes." International Economic Review. February 1994.

U.S. Census Bureau, Current Population Reports. Income in the United States: 2002. September 2003.

                                    Hillstrom, Northern Lights

                               updated by Magee, ECDI

CONSUMER PRICE INDEX

The consumer price index (CPI) provides a method for calculating the price changes that consumers and household managers face over a stated period. Even though the CPI focuses primarily on consumer prices, its calculations are also of great direct value to governmental and business groups. Yet, at the same time, the CPI is the most commonly used price-level indicator. The CPI is a nationwide measure of a weighted measure of prices. It has the capability of consistently measuring changes in prices over periods.

The CPI serves two population groups: urban wage earners (CPI-U) and clerical workers (CPI-W). The CPIU represents about 87 percent of the U.S. population and is based on the expenditures of all families living in urban areas. The CPI-W is a subset of the CPI and is based on the expenditures of families living in urban areas who meet additional requirements. At least one person in the family has to earn more than one-half of the family's income from clerical or hourly wage occupations. The CPI-W represents about 32 percent of the total U.S. population.

COST-OF-LIVING INDEX

Occasionally the term cost-of-living index is substituted for the term CPI. Nevertheless, to take in all the factors of paying to live would require the inclusion of calculations including every consumer's goods and services. Thousands of items are already included, and sheer volume forbids including all of them.

CONSTRUCTION OF THE CONSUMER PRICE INDEX

The basic CPI is calculated monthly by the U.S. Bureau of Labor Statistics. To construct the CPI, a theoretical market basket is filled with several thousands of carefully selected goods and services that reflect amounts and types of purchases by consumers. The purchases made will be included in the calculations on a sample basis. The sample data come from interviews with several families selected at random from the two population groups: CPI-U and CPI-W. The goods and services are divided into more than 800 categories and then arranged into eight major groups: food and beverages, travel, apparel, transportation, medical care, recreation, education, and communication.

In an overly simplified example, the CPI would work like this:

Suppose you purchase one each of five different items and services at the prices indicated below. Since the quantity of items and service are all the same, it will not be necessary to weight the items.

Now suppose the quantity purchased differs with the various items. It will be necessary to weight the items.

The average cost is then compared to a base-year cost to calculate the CPI.

BASE YEAR

To calculate the CPI, a base year (usually a starting time such as a month and a year) should be selected. The base-year value is ordinarily shown as a percentage with the percentage symbol omitted, often 100.0. An example might be Base Year percentage 100.0 and Current Value 139.9. The base-year value is usually some time in the past. The point of the base year is to serve as a factor in calculating price changes.

CHALLENGES IN SECURING THE DATA

Consumers vary their retail buying decisions based on many criteria—such as convenience, color, size, and taste. Nevertheless, they do change their minds. "Change" is one of the most important factors with which the CPI must deal in its quest to ensure that the price data reported are accurate. As brand-new major items begin appearing in retail stores, the CPI may "suddenly" need to investigate nationwide for items that a short time ago were not even on store shelves. Even beyond this, the timing for the newly arrived products and/or services may not be predictable. The CPI obviously lives in a world of challenges.

INFLATION

Prices of goods and services are tracked by the CPI because significant increases in retail prices may affect the overall results and create a grand total increase in prices. This, of course, suggests inflation. Retailers take note of price increases that are affecting the products with which they deal. They may very likely consider this as justification for raising their own prices, which results in inflation. The role of the CPI has been to measure change in prices.

Before the 1970s the average consumer did not tend to devote much attention to changes in the price levels. With the advent of the CPI, however, any strong rises in inflation and reporting of such by the newspapers and other media literally made headlines. More citizens sought to increase their knowledge of inflation.

Escalation is a technique of using strategies to handle inflationary data as positively as possible. Escalation agreements may use the CPI to adjust payments planned and subject to adjustment based upon results of the periodically published the CPI reports.

EFFECT OF SEASONAL FLUCTUATION

The CPI has found it necessary to calculate seasonal fluctuation so as to distinguish bona fide changes in the value of money as contrasted to changes that make their appearances on a repetitious basis.

SAMPLING ERRORS

The CPI measures price changes based on sampling. This means that even when data are handled accurately, the "luck of the draw" may cause the sample mean to differ from the population mean. Sampling "errors" are not mistakes. They are actually "differences."

PRODUCER PRICE INDEXES

Producer price indexes are the calculated values of items that are added to manufacturing work in progress. After the items are added in, they become part of the total retail price of the goods and/or services (the CPI).

DISSEMINATION OF CPI DATA

It is quite easy to obtain information about the CPI. An annual index is published every January. Indexes are also published for geographical areas for both the CPI-U and CPI-W.

see also Pricing

bibliography

Schultze, Charles L., and Mackie, Christopher (Eds.) (2002). At what price?: Conceptualizing and measuring cost-of-living and price indexes. Washington, DC: National Academy Press.

U.S. Department of Labor. Bureau of Labor Statistics. Consumer Price Index Home Page. http://www.bls.gov/cpi

G. W. Maxwell

Consumer Price Index

What It Means

The Consumer Price Index (CPI), one of the most important economic indicators in the United States, measures the change in prices that consumers pay for goods and services from year to year. This figure tracks inflation (a general rise in prices) or deflation (a fall in prices). A large increase in the CPI over a short period of time represents growing inflation, and a drop in the CPI signifies deflation, both of which can be harmful to an individual’s finances and a nation’s economy. Generally speaking, moderate and steady yearly inflation rates indicate a stable economy. When prices change rapidly, it usually means that the economy is in trouble. Because erratic price shifts can have such a devastating effect on the economy, the U.S. government takes extensive measures to chart, or figure out, the Consumer Price Index.

Consumers pay close attention to this figure as well. Because the CPI dictates the yearly income for many Americans whose wages rise according to the annual cost of living increase, it is one of the most closely scrutinized of all the economic indicators (statistics that reflect the health of the economy). Economists estimate that the CPI affects the earnings of approximately 2 million union workers, the payments to almost 50 million people on social security (federally sponsored financial benefits, including disability income, military veteran’s pensions, and public housing assistance), the value of food stamps for 20 million recipients, and the cost of school lunches for more than 25 million children.

When Did It Begin

The United States began charting price changes in 1893. The figures derived from these calculations became increasingly important at the beginning of the twentieth century with the growth of labor unions (workers’ organizations that bargain for their members’ wages, benefits, and working conditions). Business owners and union leaders relied on this information to negotiate wage increases that were in step with inflation. After World War I (1914–18) U.S. policymakers realized that a more accurate system would be necessary to monitor the staggering fluctuations of the wartime and postwar economies; thus, in 1919 the Bureau of Labor Statistics began calculating the CPI, extending their research back to 1913, the year before the war started.

In the 1930s, when Keynesian economic theory (which calls for government intervention to stabilize the economy) started to displace laissez-faire economics (trade without government control or interference) in the United States, government economists began to rely more heavily on the CPI to establish economic policies, including tax rates. Later, as government efforts to control inflation depended increasingly on monetary policy (managing the amount of money in circulation), the CPI was also an important measure. If the CPI indicated that prices were rising too quickly, the Federal Reserve (the U.S. central bank) increased interest rates (fees charged to borrow money) in order to curb spending and bring prices back down to more reasonable levels. In contrast, economic declines and fears of deflation led the Federal Reserve to do the opposite, lower interest rates, in order to encourage consumer spending and, in turn, to bring prices back up. Since its inception, the CPI has remained one of the most reliable indicators of the health of the country’s economy.

More Detailed Information

In the United States the CPI is determined by the U.S. Department of Labor’s Bureau of Labor Statistics (BLS), which surveys the spending habits of American families and monitors retail prices throughout the country. A team of BLS field representatives visits 24,000 to 29,000 American families per month to conduct interviews and compile data on the items they buy. Participants are also asked to record their purchases in diaries. In addition, the BLS charts the cost of approximately 90,000 goods and services in more than 20,000 retail stores in 85 representative cities. The survey covers most commonly purchased everyday products and services, such as shoes, motor fuel, produce, medical care, washing machines, and automobile repairs. Results are compiled monthly and published the second week of the following month on the BLS website. For example, the CPI for March 2006 would be posted by April 15, 2006.

Calculating the CPI is more complicated than merely monitoring price changes. To figure out what average Americans spend in a month to meet their daily needs, the BLS separates goods and services into eight categories: food and beverage, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. A computer program is then used to compile a fixed set, or “market basket,” of representative items drawn from each of the categories.

Each month the BLS publishes the CPI as a percentage increase or decrease of the average cost of the market basket. A typical monthly BLS bulletin might read as follows: “The CPI for American consumers rose 0.2 percent in February 1998.… For the 12-month period ending in February, the CPI has increased 1.7 percent.” This would mean that the average cost of goods (or cost of living) for Americans is 0.2 percent higher than it was in January and 1.7 percent higher than it was the previous year.

To make this index more meaningful for specific groups of Americans, the BLS publishes numerous CPIs. The two main figures 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). These two measures divide Americans according to their income, with the CPI-U being the higher of the two income brackets. There is also a separate index for each of the 26 major metropolitan centers and 4 geographic regions in the country. One of the primary weaknesses of the system is that the BLS collects data only in urban areas, and the CPI therefore does not accurately reflect pricing in rural areas. Nevertheless, the CPI is believed to be a reliable economic indicator for 87 percent of the population.

Recent Trends

In the United States the CPI has increased between 1.6 and 3.4 percent per year from 2000 to 2006. The lowest rate of increase (1.6 percent) came between 2001 and 2002. Twice between 1999 and 2006 (from 1999–2000 and from 2004–5) the country saw inflation rise 3.4 percent. During this time costs for medical care increased by about 4 percent per year, while costs associated with housing rose by 2.5–4 percent annually.

The greatest increases in this period were in the cost of motor fuel. For example, from 1999 to 2000 the cost of motor fuel increased 28.4 percent, and from 2004 to 2005 gas prices rose another 22.2 percent. Consumers also paid steadily more for utilities, such as water and electricity, with a 10.6 percent increase from 2004 to 2005 and typical increases ranging between 7.5 and 8.5 percent. A notable exception occurred in 2002, when utility prices dropped by 6.1 percent compared to 2001. There have been only moderate increases in costs for food (about 2.5–3 percent annually), and clothing costs decreased between 2000 and 2006 by about a half percent a year.

CONSUMER PRICE INDEX

The Consumer Price Index (CPI) is a continually updated statistical survey of the prices consumers are paying for various basic goods and services. The Bureau of Labor Statistics (BLS) defines the prices it wants to track of a group or "basket" of about 2,400 typical consumer goods and services. (The "contents" of a basket can be quite varied, e.g., medical care, transportation, housing prices, or the current prices of entertainment, clothing, and food.)

Hundreds of BLS field representatives visit an average of 24,000 to 29,000 families and thousands of retail stores in 85 representative cities to determine the current prices paid and charged for each specific good. (A typical example of BLS inquiry might include, "Men's high work shoes, elk upper, Goodyear welt, size range 6 to 11.") During the next 20 days which follow visitations, government analysts use computers and complex computer programs to combine, sort, and refine all their price data, taking into account the fact that some goods play a more important role in the economy and in household budgets than others. (A change in the price of gasoline, for example, will have a much greater impact on a family budget than will a change in the price of toothpaste.) About the middle of every month, the Bureau publishes the CPI for the previous month. A typical BLS news release begins: "The CPI for all urban consumers rose 0.1 percent in February 1999 . . . to a level of 164.5 (1982–84 = 100). . . . For the 12-month period ended in February, the CPI has increased 1.6 percent."

The first attempt in the United States to use an index to compare price changes was prepared for the U.S. Senate in 1893. When labor and management began meeting to hammer out labor agreements in the early years of the twentieth century, they needed an accurate, official CPI so workers would receive automatic wage increases that kept pace with inflation. During World War I (1914–18), inflation accelerated, and an accurate CPI became more important than ever.

When Keynesian economic theory gained acceptance during the 1930s, the CPI became a tool government economists could use to fine-tune fiscal policy. For example, if the CPI showed that prices were falling, the government might become concerned that demand was weak and could lower taxes to stimulate consumer spending. As the twentieth century closed, the CPI remained one of the most closely watched measures of the health of the U.S. economy. Besides determining appropriate wage increases, the index was also used to calculate Social Security payment adjustments and income tax brackets.

See also: Inflation, Keynesian Economic Theory

CONSUMER PRICE INDEX

A computation made and issued monthly by the Bureau of Labor Statistics of the federallabor departmentthat attempts to track the price level of designated goods and services purchased by the average consumer.

The consumer price index (CPI) is an indicator of the rate of inflation in the economy because it measures changes in the cost of maintaining a particular standard of living.