Consumer Price Index (CPI): What is it, Calculation, Types, Importance

The Consumer Price Index (CPI) and Wholesale Price Index (WPI) are two of the principal measures of inflation tracked by economists and policymakers. Both indices are released monthly by national statistical agencies and gauge price changes over time. However, they differ fundamentally in their scope and methodology as they are designed to capture inflation at distinct stages of the production process.

The CPI measures the average price change for consumer goods and services. It tracks retail prices paid by urban households on a basket of items representative of typical consumer expenditures. Items range from food, housing and apparel to transportation, healthcare and recreation. The CPI aims to indicate how much consumer purchasing power is eroding due to rising living costs.
In contrast, the WPI monitors price changes earlier in the supply chain by focusing on the wholesale stage. Rather than consumers, it measures the prices received by domestic producers for their output of sold intermediate or final goods. The WPI covers the prices of commodities and products before they reach the retail level.

While both indices provide timely monthly inflation data, they differ in their construction and economic significance. The CPI offers insights into rising costs confronting households and their welfare.
The WPI provides an early indication of producer price trends that feed into the consumer pipeline. It also signals potential pressures on corporate margins and producer wholesalers. Understanding the distinct methodologies and perspectives of the CPI and WPI is important for analyzing current inflation dynamics from different angles within the economy.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The CPI is a key economic indicator used to gauge inflation and deflationary trends. It acts as a cost-of-living index and is used to adjust payments to those who rely on a fixed income, including Social Security recipients. 

The Ministry of Statistics and Program Implementation (MoSPI) is responsible for calculating and determining the CPI market basket in India.
CPI in India, is published by the National Statistical Office (NSO).

What is the origin of the consumer price index?

The consumer price index (CPI) traces its origins back to World War I and the need to adjust wages for the rising cost of living. The Bureau of Labor Statistics (BLS) pioneered early efforts to track prices paid by consumers and quantify cost-of-living changes. Over the years, the methodology was refined to improve accuracy and expand coverage. Today the CPI is the foremost measure of consumer inflation in the United States.

The BLS began publishing a national wholesale price index in 1902 to measure price changes from the producers’ side. But during World War I, the need emerged for a consumer-based index that could guide wage adjustments. As President Woodrow Wilson’s administration introduced price controls and rent caps, workers faced rapidly rising prices that eroded living standards. In 1919, the BLS published its first embryonic consumer price index, covering retail food prices in major industrial cities. In 1921, the BLS expanded the index to track prices urban wage earners paid for food, clothing, fuel, light, and rent. This early CPI used a relatively narrow set of goods and was based on just 51,000 family budget surveys in only 15 industrial cities.

Over the 1920s and 1930s, BLS economists recognized shortcomings in the pioneering CPI methodology. They worked to expand the sample size and geographic coverage. In 1940, the BLS introduced the CPI-U (Consumer Price Index for All Urban Consumers) which is still the broadest CPI measure.  During World War II, the Office of Price Administration utilized the revamped CPI-U to monitor inflation and maintain price controls. This demonstrated the importance of the CPI as a macroeconomic indicator. In 1952, the BLS added the CPI-W (Consumer Price Index for Urban Wage Earners and Clerical Workers) which it still publishes monthly. 

The BLS substantially advanced CPI methodology in the 1950s and 1960s. Item samples were broadened and made more representative of consumer spending. Outlet samples were expanded to capture geographic differences. The BLS introduced probability sampling techniques to select outlets and items tracked. This improved index accuracy and reliability. In 1978, the BLS modified the CPI to accommodate changing consumer behaviors. A new standard base period of 1967=100 was established. The CPI was restructured from a fixed to a variable basket index that better reflected product substitutions. By the 1980s, the CPI methodology evolved into a model that underpins today’s index. 

The introduction of scanners and computers in the 1990s allowed much faster collection of price data from retailers. This boosted the number of price quotes feasible per month from 5,000 to over 100,000. The BLS now utilizes geometric means and other advanced formulas when calculating price averages. Complex item weighting and seasonal adjustment methods refine today’s CPI accuracy.

What is the India Consumer Price Index? 

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by consumers for a market basket of consumer goods and services. In India, the CPI is calculated and published monthly by the Central Statistics Office (CSO) of the Ministry of Statistics and Programme Implementation. Price Statistic Division (PSD) is the department inside the Ministry of Statistic and Programme Implementation (MoSPI) responsible for publishing monthly broad based Consumer Price Index for all Indian Rural, Urban and combined for all States and Union Territories (UT) at All India level.

The CPI is used as a key indicator of inflation and deflation in the Indian economy. It captures the changes in the level of retail prices of frequently purchased goods and services like food, fuel, housing, clothing, transportation, education, etc. that Indian households buy for their daily consumption. There are multiple CPIs calculated in India for different segments of the population and regions, but the most important ones at the all-India level are: Rural and Urban CPI. 

How is the consumer price index calculated?

The consumer price index (CPI) is constructed using a Laspeyres price index formula that measures the weighted average price changes for a fixed basket of goods and services representative of consumer expenditure patterns.  The CPI calculates the change in the cost of purchasing a predetermined set of commodities relative to the cost of buying the same set in a base period. The index aims to capture the relative change in the amount consumers need to spend to reach a constant level of utility and maintain their standard of living.

The CPI formula uses a weighted arithmetic mean of the percentage changes in prices across various items. The weights assigned denote the relative importance of each item estimated through its share in consumer spending.

Mathematically, the CPI is calculated as:

CPI = (Summation of (Pit/Pib) x Wib) x 100 

Where,

Pit = Price of item i in the current period t

Pib = Price of item i in the base period b 

Wib = Weight assigned to item i based on base period expenditure

The prices for select goods and services are collected periodically from sample retail markets and outlets by field investigators. The price changes for each item are aggregated using the weights to arrive at the composite CPI.

How is the consumer price index weighted?

The consumer price index (CPI) uses a weighted average approach to aggregate the price changes across the many goods and services in the consumption basket. Appropriate weights are assigned to each item based on its relative importance or share in the total expenditure made by households. This weighting pattern helps account for both price rise and consumer spending priorities. The weight for any given CPI commodity is calculated as the proportion of total consumer expenditure allocated to it in the base period. In the Indian context, groups and sub-groups at state and national level are selected for weighing and further measuring the price levels. The recommendation of the ISWG-PS for India needs to be seen in this context.

For instance, the weight for food in the CPI would be 0.50, if households spent Rs. 5000 per month on food items which comprised 50% of their total monthly expenditure.  The relative weight of each item remains fixed in between revisions and new weight assignments. The weights are updated periodically with changes in consumption behavior captured via fresh household expenditure surveys. The weight attached to any good or service group demonstrates its significance in consumer budgets.

Essential commodities which take up a major portion of household expenses get higher weightage. For example, food and beverages have a weight of around 45% in the CPI basket while recreation has only a 6% weight. The Indian CPI has four main commodity groups namely – Food and Beverages, Pan, Tobacco and Intoxicants, Fuel and Light, Clothing and Footwear. Food and Beverages gets a predominant weight of around 45% reflecting the large share of Indian household budgets allocated to food consumption. 

Within each major group, further disaggregated weights are assigned to more specific commodity sub-groups and individual items. For instance, within Food and Beverages, there are separate weights for cereals, milk, eggs, spices etc. based on their respective contribution. The weighting pattern of the CPI aims to represent the consumption priorities and spending habits of the target population segment like industrial or agricultural workers. The weight assignments are based on comprehensive field surveys and data analysis by the statistical agencies.

IMPUTATION METHODOLOGY FOR CPI

National Statistical Office (NSO) is responsible for undertaking activities for imputing missing sub-groups/groups by using the next level up index i.e. Groups/General CPI calculated with observed price during COVID lockdown period in pursuance to recommendations of ISWG-PS. 

Formula I Imputed Sub-group Index (Food Group) = (Last Observed Index of Sub-group) x (Food Index of Current Month/Food Index of last Observed Month) 

Formula II Imputed Sub-group Index (Non-Food Group) = (Last Observed Index of Subgroup) x (General CPI of Current Month/General CPI of last Observed Month).

An example table wise categories of indices are covered in the image below for the month of April 2020 and May 2020. 

Group code	Sub group code	Indices of Groups / Sub Groups
	1.1.01	Cereals and products
	1.1.02	Meat and Fish
	1.1.03	Egg
	1.1.04	Milk and products
	1.1.05	Oils and fats
	1.1.06	Fruits
	1.1.07	Vegetables
	1.1.08	Pulses and products
	1.1.09	Sugar and confectionery
	1.1.10	Spices
	1.2.11	Non alcoholic beverages
	1.2.12	Prepared meals, snacks, sweets etc
1		Food and Beverage
2		Pan, Tobacco and Intoxicants
	3.1.01	Clothing
	3.1.02	Footwear
3		Clothing and footwear
4		Housing
5		Fuel and Light
	6.1.01	Household goods and services
	6.1.02	Health
	6.1.03	Transport and communication
	6.1.04	Recreation and amusement
	6.1.05	Education
	6.1.06	Personal care and effects
6		Miscellaneous

What are the types of consumer price index?

There are types of CPIs constructed to represent different segments of the population and consumption patterns.

CPI types include commodity-specific CPIs tracking price changes in individual product categories like food or energy. Specialized CPIs are also published, like the CPI for elderly population measuring inflation for senior citizens. Core CPI excludes volatile commodities like food and energy for analyzing underlying inflation. Export and import price indices monitor international trade inflation. The appropriate type of CPI is chosen based on the specific purpose it will serve and the target demographic group.

At the national level, there are four Consumer Price Index (CPI) numbers. These are:

1. CPI for Industrial Workers (IW),
2. CPI for Agricultural Laborers (AL)
3. CPI for Rural Laborers (RL)
4. CPI for Urban Non-Manual Employees (UNME).

CONSUMER PRICE INDEX FOR RURAL

Consumer Price Index: 

Generalized level of prices of goods and services that rural livelihoods acquire for the purpose of consumption is measured at this rural stage. CPI(R) has also been entrusted to NSSO(FOD) from the Department of Posts for 1181 villages across the country out of which 5 villages pertaining to Lakshadweep are carried out by DES (Directorate of Economics and Statistics).

The DOP, department of post collects the price and transfers the data to Field Operation Division (FOP). The FOP As a body is responsible for regular price collection and transfer of data monthly in the web portal or CPI (U). 

CONSUMER PRICE INDEX FOR URBAN

Consumer Price Indices (CPI) measure changes over time in the general level of prices of goods and services that households acquire for the purpose of consumption. CPI numbers are used as a macroeconomic indicator of inflation, The numbers are also used as a tool by governments and central banks for achieving inflation targets and measures for regular observance of price stability. CPI is also used for indexing Dearness Allowance (DA) to employees for increase in prices. CPI is therefore considered as one of the most important economic indicators. The survey is conducted on behalf of CSO(PSD). The present base year for CPI (U) is 2012=100. Price data collection is done for 1078 quotations per month from 310 towns.

CPI for Urban Non-manual Employees, CPI(UNME)

An urban non-manual / non-physical employee is defined as a person who procures his or her 50% or more of payment or income from gainful employment on non-manual in the non agricultural fields and urban sector. 

CPI for Industrial Workers, CPI(IW)

Usually, workers which are engaged in any of the seven sectors like factories, mines, railways, plantation, public motor transport undertakings, distribution establishment at Ports and docks level, electricity generation departments. This particular index covers only manual workers regardless of their income levels.

The Labour Bureau collects the retail prices used in the compilation of CPI(IW). There are these part-time price collectors as government employees which are employees of the State Directorates of Economics and Statistics or State Labour Commissioners’ offices on weekly, monthly and half yearly basis or these part time collectors are picked from selected markets and shops.

A staff at the Labour Bureau is responsible for carrying out a survey in learning six-monthly house rents for compilation of house rent index, which is regularly monitored and revised in January and July every year.

They record over 15,000 retail prices spanning necessary consumer goods and services. The sample basket includes food, beverages, housing, fuel, medical services, transport, clothes and other miscellaneous items weighed proportionally to estimated household spending patterns. 

To represent consistent living costs, the CPI holds weights constant periodically revised using consumption expenditure surveys covering urban non-agricultural labor. Currently, food alone comprises over 45% of the basket emphasizing basic necessities for lower income families. Price quotes observe standard specifications minimizing substitution variability ensuring accurate price change monitoring over time.

Released monthly with a 3-4 week delay, the IW CPI presents valuable inflation insights. Industry bodies reference the index when bargaining compensation agreements shielding workers from high living expenses. By law, the index also guides the Minimum Wages Act mandating floor pay reflective of prevailing local price levels.

Disaggregated data moreover isolate cost increases within food, fuel or housing allowing targeted policy responses. A high food inflation reading for instance prompt grain stock releases or duty cuts to contain household budgets. The core index excluding volatile components also aids fiscal and monetary authorities calibrating broader anti-inflation efforts.

Statistics on geographic and sectoral inflation differences expose regional imbalances necessitating coordinated action. Price variability across large, medium and small town categories often informs tailored intervention needs. Consistently rising factory CPI readings as presently witnessed also necessitate interest rate adjustment by the RBI preserving macro stability and purchasing power over the long-run.

Through its wide coverage and targeted utility, the IW CPI plays an important surveillance role supporting priorities around employment, wages and social welfare especially for disadvantaged industrial employees depending on reasonable living standards.

2. CPI for Agricultural Labourer (AL)

An agricultural laborer is a person who is employed in the agricultural field or agricultural occupations and who is paid by cash on hire or by kind and cash partly. 

A rural labour is defined as a person who does manual work in the agricultural and non agricultural fields of Rural areas. They are often paid in cash or kind or partly in cash and partly in kind. 

The rural labour household is defined as one which derives its major income during the last 365 days from income gathered by wage-work and rural labor. Income is also gathered from people who are self-employed, whose wages are not related to manual or physical work. 

Agricultural Labour Household is defined as a household who are able to earn 50% or more of the total income (from gainful occupation) during the last 365 days from wage-work (manual labour) in agriculture fields or occupation in agriculture. 

Prices are collected on the fixed price collection day which may be a “Hat” day for “Hat” or non-daily markets and any market day for daily markets. CPI(AL) is a subset of CPI(RL) series.

The basket of goods and services for CPI-AL includes food, pan, tobacco, intoxicants, clothing, bedding, footwear, education, medical care, recreation, household goods, and other miscellaneous groups. The weights assigned to these groups in the overall index are based on the results of the Consumer Expenditure Survey conducted by the National Sample Survey Office. Food has the highest weight of over 57%, reflecting the larger share of expenditure of agricultural laborers on food items. This is followed by intoxicants, clothing, miscellaneous goods and services, etc.

The Labour Bureau collects retail prices for select items in the CPI-AL basket from randomly selected villages across India. The prices are collected from local markets and shops during the middle of every month. Around 1280 markets and shops are covered in the price collection. The prices collected relate to the preceding month. For example, the prices collected in the middle of July would relate to the month of June. Based on these prices, the Labor Bureau calculates the changes in prices month-on-month as well as year-on-year. This forms the basis for calculating the CPI-AL every month.

Several procedures are followed to ensure the accuracy and reliability of the CPI-AL. These include detailed checklists and guidelines for price collection, rigorous scrutinizing and editing of the raw price data, procedures for replacing missing price quotations, etc. Quality control checks are also conducted by headquarters and regional offices of the Labour Bureau. Further, an elaborate weighting diagram is used to aggregate the price relatives at successive stages to arrive at the overall index. 

Trends in CPI-AL provide insights into the economic conditions facing agricultural laborers. For instance, high food inflation adversely impacts agricultural laborers who spend a large portion of their income on food. The CPI-AL usually rises at a faster pace than the national CPI due to the higher weight of food items. The government uses movements in CPI-AL for determining minimum wage rates for agricultural workers. It is also used for calculating Dearness Allowance payable to government employees as a relief for inflation. 

3. CPI for Rural Labourer (RL)

The Consumer Price Index for Rural Laborers (CPI-RL) is a monthly statistical indicator published by the Labour Bureau, Ministry of Labour and Employment. It measures the changes in the retail prices of goods and services consumed by manual labor households in rural areas across India. The CPI-RL provides insights into the purchasing power and living costs of landless agricultural and non-agricultural rural workers. 

The basket of commodities for the CPI-RL consists of food, pan, tobacco, clothing, footwear, housing, education, medical, household goods and services, and other groups. Food articles have the highest weightage of over 46%, followed by miscellaneous goods and services, fuel and light, pan tobacco and intoxicants, clothing, etc. The weights are determined based on the consumption pattern of rural laborers as per the Consumer Expenditure Survey conducted by NSSO.

To construct the index, retail prices are collected on a monthly basis from around 1181 villages across India. The prices pertain to the preceding month and are gathered during the middle of the month by price collectors of the Labour Bureau. The sampled villages are spread across 315 markets/shops covering 20 states. The prices reflect the actual retail prices paid by rural laborers for their day-to-day consumption.

Stringent quality control measures are undertaken during the price collection, scrutiny, compilation and calculation processes to ensure accuracy. The price data is carefully edited to remove outliers or abnormal price variations. Procedures are in place to impute missing price quotations based on logical comparisons. The price relatives are aggregated using appropriate weights at successive stages to finally arrive at the all-India CPI-RL. 

The CPI-RL indicates the price situation and inflationary pressures faced by rural laborers. Persistently high food inflation adversely affects rural labor households who spend a large share of income on food. The CPI-RL usually rises at a faster rate compared to CPI-Industrial Workers and CPI-Agricultural Laborers owing to the higher weight of food in the index. The government utilizes the CPI-RL for determining minimum wages and regulating Dearness Allowance for rural workers. It also offers insights for designing policies and schemes aimed at alleviating rural poverty.

4. CPI for Urban Non-Manual Employees (UNME)

An urban non-manual / non-physical employee is defined as a person who procures his or her 50% or more of payment or income from gainful employment on non-manual in the non agricultural fields and urban sector. 

The Consumer Price Index for Urban Non-Manual Employees (CPI-UNME) is a key economic indicator published monthly by the Labour Bureau, Ministry of Labour and Employment. It measures the temporal changes in the retail prices of commodities and services consumed by non-manual urban employees across India. The CPI-UNME provides insights into the cost of living and inflationary trends affecting white-collar urban households.

The consumption basket of CPI-UNME consists of food, pan, tobacco, intoxicants, clothing, footwear, housing, education, medical care, recreation, household goods, and other miscellaneous expenditure groups. Food and beverages have the highest weight of around 44%, followed by miscellaneous goods and services, housing, education, etc. The weighting diagram is based on the consumption pattern of non-manual employees as revealed by the Consumer Expenditure Survey of NSSO. 

For compiling the index every month, retail prices are collected from about 88 urban markets across 78 cities in 24 states. The Labour Bureau has price collectors who gather the prices from local shops and markets during the middle of the month. The prices pertain to the preceding month. Rigorous data validation procedures are followed to remove outlier prices and impute missing values.

At the first stage, price relatives are calculated for each item in the basket by comparing its current price with base year price. These are aggregated using item weights to obtain group-wise indices. In the subsequent stages, the group-wise price indices are combined using their respective expenditure weights to derive the overall national index. Appropriate care is taken to account for items with relatively higher expenditure shares.

The CPI-UNME indicates the price pressures faced by non-manual urban employees and how much real incomes have changed over time. Trends in CPI-UNME are analyzed to understand spending and consumption patterns of the segment. For instance, higher education and healthcare inflation warrant policy action. The government uses CPI-UNME for determining dearness allowance for non-manual central government employees and pensioners. 

How The Compilation Of CPI Is Carried Out?

Field Operations Division (FOD), department under NSO, MoSPI is responsible for collecting monthly price data from 1114 urban markets and 1181 selected villages by personally visiting these locations. The price data collected is uploaded on a web portal developed by NIC. Proper validation and verification is carried out by the Price Statistics Division (PSD). NSO follows regularly revised well established and internationally accepted methodology and practices while handling the missed price situations, change in item specification and seasonal items.  

a) Handling temporarily missing prices: The temporarily missing prices are imputed by using following formula;

Imputed Price = Last Month’s Price x Average of Ratio (Current Month to Last Month’s price, Based on Quotations having prices in both months) i.e. (Imputed Price) t= (Price)t-1 x Avg. of (Price t/ Price t-1)

b) Handling permanently missing prices: The allocated weights of such items are distributed (imputed) on a pro-rata basis to the related items to respective sub-group or group. In such cases, the effective size of the item basket will be lessened by no. of items permanently out dated. This practice is rarely followed in CPI.

c) Change in item specification: Base Price is modified, when shop or item is substituted, by using following formula;

New Base Price = Price of new specification of last month X Old Base Price Price of old specification of last month

d) Handling situation for Seasonal items: Treatment of seasonality is applied only in case of vegetables and fruits. Whenever, in a particular month, the prices of some of the items are either not reported at all or reported in less than 25% quotations of the total allotted quotations of that State/UT then weights of such items are imputed on pro-rata basis to the items first in the respective section (i.e. root vegetables, leafy vegetables, fresh fruits, and dry fruits, etc.)

What Approach Is Used To Compile CPI In India?

The Consumer Price Index (CPI) is compiled by using a bottom-up approach. These are the steps

(a) The first step is estimating prices under The elementary indices, these are the lowest level of aggregation where prices of each good or service are combined into price indices for which specific expenditure weights are, generally, not available. For example, Prices of different varieties of Rice or Prices of Rice from different outlets. The Price Ratios (current month to base period) are combined by taking simple geometric mean.

(b) The second step is Aggregating these elementary price indices to higher level indices using relative levels of consumer expenditure as weights. At this level, a Laspeyres‐ type index formula is mostly used.

(c) In the third step, list of Items Indices under Sub-groups or Groups indices are, first, compiled for Rural, Urban & Combined sectors of each State and Union Territories. All India Indices are compiled by aggregating weighted State and Union territories indices, for Rural, Urban & Combined sectors, respectively. 

How is the CPI used?

The most common use of the CPI is as an indicator of inflation. Rising prices lower consumers’ purchasing power and reduce their standard of living. Policymakers, businesses, and households monitor the CPI closely to gauge changes in the cost of living over time. The headline CPI covers a broad range of categories, providing a snapshot of economy-wide inflation. Central Banks (Reserve Bank of India) uses CPI trends to guide their decisions on interest rates. An increasing CPI prompts them to raise rates to keep inflation under control. Individuals use the CPI to negotiate pay raises that keep pace with living costs. Businesses build price increases into contracts using the CPI. 

The CPI is also used to index government programs and benefits. Social Security, pensions, and veterans’ benefits are all adjusted annually based on the CPI. This protects recipients’ purchasing power. Tax brackets, standard deductions, and exemption thresholds are also indexed to CPI inflation. Without indexing, real tax burdens would rise over time as incomes increase. Indexing prevents “bracket creep” and helps keep tax burdens steady in real terms.

What are the different approaches to the consumer price index?

There are three main approaches used to calculate the consumer price index (CPI). The economist approach focuses on maintaining the constant utility of the consumption basket. The spending approach aims to measure price changes based on consumer expenditure patterns. The transaction approach prices the actual transactions consumers make each month. 

1. Economist approach

The economist approach constructs CPI bundles to deliver a constant level of utility or satisfaction to consumers. As relative prices change, consumers alter their spending to optimize utility. This approach substitutes cheaper items within categories to hold utility steady. While theoretically sound, implementing utility consistency is difficult in practice. Estimating constantly changing consumer preferences introduces uncertainty.

2. Spending approach

The spending approach weights CPI categories according to their share in total consumer expenditures. Actual spending patterns determine the relative importance of each category. As consumption habits evolve, the composition of the CPI basket is updated to stay relevant. This pragmatic approach has the advantage of tracking prices for goods and services people are currently buying. A downside is excluding categories where prices are rising rapidly before spending shifts. 

3. Transaction approach

The transaction approach collects price data on specific items at retail outlets each month. Price changes are then calculated for these matched models. This method provides a direct, accurate measure of price trends. However, constantly resampling products and outlets is logistically demanding. Representativeness decline over time as new products emerge. Infrequently purchased items also pose challenges.

Calculating the consumer price index requires balancing theoretical and practical constraints. The economist utility approach is conceptually ideal but hard to perfectly implement. The spending approach provides a more feasible approximation using actual expenditure weights. However, it risks missing substitution effects and new product inflation. The transaction approach offers direct measurement but declining representativeness over time.

In practice, statistical agencies incorporate elements of these approaches while recognizing inherent trade-offs between precision, timeliness, and transparency. The CPI methodology continues to be refined, with chained indices addressing previous shortcomings. Despite imperfections, the CPI broadly succeeds in its core purpose of tracking consumer inflation when constructed through rigorous methods. Ongoing basket improvements aim for relevance and accuracy to support sound economic decision-making.

What index numbers can be used in the consumer price index?

Common indices used include Lowe, Laspeyres, Paasche, Young, and symmetric indices like Fisher and Törnqvist. Each has advantages and disadvantages relating to data needs, complexity, biases, and accuracy. 

1. Lowe indices

Lowe indices use the arithmetic mean of prices in the base and current period when calculating the index. This means taking the simple average of the base price and current price for each item, then aggregating these average prices across all items in the basket using base period quantities as weights. A benefit of Lowe indices is they satisfy the time reversal test, an important axiom for price indices. Index B/A must equal 1/x, if index A/B yields x.

Lowe indices are also easy to explain and compute compared to more complex indices. However, they still suffer from substitution bias, meaning they overstate inflation somewhat. Consumers substitute relatively less expensive items when prices change. Lowe indices use fixed weights and don’t account for this. But their approximation of the ideal Fisher index makes Lowe a reasonable pragmatic choice.

2. Laspeyres and Paasche indices

The Laspeyres index weights current prices by base period quantities. It measures the cost of purchasing the original fixed basket at new prices. As costs rise due to inflation, Laspeyres indices systematically overstate the impact because consumers substitute items. Paasche indices use current period quantities for weighting, capturing substitution effects.

However, Paasche understate inflation when new goods are introduced. Consumers shift spending toward new products, and the price index misses the rapid inflation. Neither Laspeyres nor Paasche satisfy key axioms like time reversal. Statistical agencies often choose Laspeyres due to lower data demands. But both indices have significant limitations that distort measurement of true inflation.

3. Young index

Young indices average all possible Laspeyres and Paasche indices that are computed between two periods. For example, with monthly data, the previous and current year would yield 12 Laspeyres and 12 Paasche indices that are averaged. This minimizes the substitution bias effects of the fixed-weight indices. However, the data requirements for calculating all permutations of Laspeyres and Paasche make Young indices infeasible for broad CPI measurement. They are primarily useful for analytical purposes rather than statistical practice.

4. Symmetric indices

Symmetric indices satisfy the time reversal property by giving equal weight to both periods. The Fisher ideal index uses a geometric mean of Laspeyres and Paasche, while Törnqvist uses a logarithmic mean. Both account for substitution effects and provide theoretically sound measures. Chained indices further break substitution adjustments into smaller increments by linking indices period-to-period. However, the complexity of symmetric indices makes them hard to explain to the public. Statistical agencies must balance accuracy versus transparency in choosing index number approaches.

No index perfectly suits all purposes. The choice ultimately depends on balancing accuracy, timeliness, transparency, and other practical constraints. Despite drawbacks, CPI index numbers broadly succeed in distilling price trends into a single statistics useful for economic analysis and policy making.

Why is the consumer price index important?

The consumer price index (CPI) holds significance for economic policymaking, government programs, businesses, and the general public. As the foremost gauge of inflation, the CPI provides crucial insights into changing cost of living and purchasing power. Its relevance and utility ensure the index remains under constant analysis to improve accuracy and reliability.

The CPI impacts government budgets through indexation of transfers and taxes. Social Security, federal pensions, and veterans’ benefits increase annually per CPI changes. Tax brackets, standard deductions, and exemptions also shift based on the index. Indexation protects against bracket creep and maintains real purchasing power. The CPI thereby influences entitlement spending and revenue collection. Fundamental analysis is essential in understanding these shifts, as it provides insights into the underlying economic factors. Private businesses utilize the CPI in setting wages, rents, royalties, alimony, child support, and other obligations. Adjusting payments by an inflation index keeps real values steady. Labor unions refer to CPI trends when bargaining pay raises. Landlords and tenants negotiate leases indexed to the CPI. Licensing contracts are often built in CPI escalators. Fundamental analysis of these trends can help businesses and individuals make more informed financial decisions.

Why is the consumer price index criticized?

While the consumer price index (CPI) serves as a key inflation gauge, aspects of its methodology draw criticism regarding potential biases. Critics argue flaws in the CPI overstate inflation, undermining its accuracy as a cost-of-living indicator and macroeconomic benchmark. Main critiques focus on the CPI’s substitution effect, quality adjustments, housing costs, and geometric weighting.

The CPI’s fixed basket structure means substitution effects are not fully captured as relative prices change. Consumers shift their spending toward relatively cheaper goods, which the CPI does not reflect well. This substitution bias tends to result in higher measured inflation rates. Chained CPIs attempt to correct for this issue and typically report slightly lower inflation.

How is the CPI sample created?

The consumer price index (CPI) depends on a rigorous sampling process to collect accurate price data each month on the thousands of items comprising consumer budgets. The CPI sample aims to capture price changes representative of urban consumers’ actual inflation experiences. Creating this sample involves extensive work by Bureau of Labor Statistics (BLS) economic analysts. The process begins by dividing consumer expenditures into over 200 categories stratified across 39 geographical areas. The BLS then selects a sample of specific goods and services within each category and city to reflect regional consumption patterns.

Items are chosen based on sales volume and importance in households’ budgets. For goods, BLS analysts visit retail stores, markets, and service establishments to identify popular brands and models. Detailed product specifications help select the exact items to be priced monthly. Outlets are also chosen through field visits, with probability sampling by store type and size. Online prices supplement in-store data. For housing, the BLS collects apartment rental rates to determine equivalent rents. Homeowners’ equivalent rent makes up over 20% of the CPI.

Rent surveys target properties representative of those in neighborhood rental markets.  Within each stratum, the BLS chooses a sample of outlets where field representatives record prices on specific items. A rotating 5-year panel process prevents outdated samples. Annually updating outlet samples captures new brands and businesses.

Data collectors visit or contact sampled outlets each month to track prices on designated items. Technology like barcode scanners facilitates efficient collection from chain retailers. For unique goods like furniture, field staff record model details. Pricing locations span online, in-store, mail-order, and phone surveys.

How sample error affects CPI?

As a statistic derived from surveys, the consumer price index (CPI) is subject to sampling errors. The CPI estimates overall inflation by pricing a sample of goods and services purchased by consumers. However, sampling a subset rather than the complete universe of transactions introduces potential biases. Controlling and measuring sampling error is necessary for the CPI to provide reliable inflation measurement.

The Bureau of Labor Statistics (BLS) carefully constructs the CPI sample to represent the full range of consumer expenditures across geographic areas and outlets. But sampling naturally has limitations. Some categories like energy experience high monthly price volatility, increasing sampling error risks. Infrequently purchased items also pose challenges.

Small samples randomly omit goods with extreme price changes, skewing the index. As the sample size decreases, the potential variation between the sample statistic and true population parameter rises. The BLS seeks samples large enough to minimize the sampling error to acceptable levels.

Non-random sampling errors also exist. These reflect systematic biases rather than random chance. For example, consistently missing certain high inflation products would underestimate the CPI. Clustering samples by location or time could also introduce bias if prices follow geographic or seasonal patterns.

To quantify sampling error, the BLS calculates item stratum standard errors and overall CPI standard errors. These help determine the extent of imprecision from sampling. Larger samples decrease standard errors and boost precision. 

Is the CPI a cost-of-living index?

No, the consumer price index (CPI) is often described as measuring changes in the cost of living, but it departs from a true cost-of-living index (COLI) in several ways. The CPI tracks prices to estimate inflation based on consumer purchasing behavior. It does not directly quantify changes in the amount of income needed to reach a constant standard of living. While closely related, the CPI diverges somewhat from a pure COLI.

What goods and services does the CPI cover?

The consumer price index (CPI) aims to capture price changes across the complete range of goods and services purchased by urban households.

Below attached table covers all the groups and subgroups which are measured for estimating CPI. 

Group code	Sub group code	Indices of Groups / Sub Groups
	1.1.01	Cereals and products
	1.1.02	Meat and Fish
	1.1.03	Egg
	1.1.04	Milk and products
	1.1.05	Oils and fats
	1.1.06	Fruits
	1.1.07	Vegetables
	1.1.08	Pulses and products
	1.1.09	Sugar and confectionery
	1.1.10	Spices
	1.2.11	Non alcoholic beverages
	1.2.12	Prepared meals, snacks, sweets etc
1		Food and Beverage
2		Pan, Tobacco and Intoxicants
	3.1.01	Clothing
	3.1.02	Footwear
3		Clothing and footwear
4		Housing
5		Fuel and Light
	6.1.01	Household goods and services
	6.1.02	Health
	6.1.03	Transport and communication
	6.1.04	Recreation and amusement
	6.1.05	Education
	6.1.06	Personal care and effects
6		Miscellaneous

How baskets of goods and services impact CPI?

The composition and weighting of the consumer price index (CPI) basket of goods and services significantly impacts the overall inflation rate. As consumer purchasing patterns change, the items and categories included in the CPI require periodic re-evaluation to maintain representativeness. The basket aim is reflecting typical expenditures to accurately measure inflation experienced by average households.

The CPI basket was historically dominated by food and apparel, which formed a large share of spending decades ago. But as incomes rose, consumer budgets shifted more toward housing, transportation, medical care, and recreation services. Failing to re-weight would have caused the CPI to overstate inflation, as consumers substituted away from the high-weighted categories.

How and when are CPI prices collected and reviewed?

The Bureau of Labor Statistics (BLS) follows a meticulous monthly schedule and process to collect and review the vast number of prices that underpin the consumer price index (CPI). Careful data collection and verification supports the CPI’s credibility as a key economic indicator. CPI data collection takes place during the calendar week containing the 13th day of each month. BLS field representatives record prices on thousands of items across retail outlets, markets, and services establishments.

Barcode scanners and tablets enable efficient in-person price captures. Data comes from varied sources. Field staff directly visit or contact stores, real estate firms, hospitals, and other outlets. Cash register tapes are collected from certain retailers. Utilities and websites provide price feeds electronically. Airlines and hotels regularly submit data. Prices are captured from online, mail order, and phone surveys as well as in-person. This blend captures the multiple ways consumers now shop and spend.

The BLS continuously reviews outlets and items to ensure representative samples as purchasing behavior evolves. During the data collection week, field staff follow carefully defined pricing procedures for each item. This includes confirming the specifications like size, quantity, brand, and model match the designated sample item. Quality checks occur during receipt to verify entries make sense based on historical patterns.

In the week following data collection, CPI analysts review the submitted prices for accuracy and consistency. Validation ensures collected prices correspond to the correct items matching the sample definitions. Anomalous data gets double-checked by contacting the field representative. Economic indicators play a crucial role in this validation process. Additionally, these economic indicators help analysts identify any inconsistencies in the collected data.

Is the CPI the best measure of inflation?

No, the CPI is not the undisputed best measure of inflation. While extensively used and vital, the CPI has recognized shortcomings that open debate regarding the optimal inflation gauge.  The CPI enjoys key strengths as a transparent, frequently updated indicator constructed through rigorous methods. It broadly represents consumers’ expenditures and experiences. CPI data collection is timely and comprehensive, supporting monthly estimates. As an official government statistic, the CPI carries authority and acceptance.

What’s the difference between CPI vs. WPI?

CPI	WPI
CPI tracks prices paid by urban consumers for a representative basket of goods and services. It covers retail purchases across 200 categories, with a focus on out-of-pocket costs.	WPI measures price changes earlier in the supply chain. It tracks prices paid by producers and wholesalers for raw materials, intermediate goods, and finished products
CPI depends on household expenditure surveys	WPI relies on business establishment surveys to determine sample composition and weighting
CPI uses stratification by geography and outlet types	WPI stratifies by industry and commodity.
CPI has a more granular product structure, drilling down to region-specific item samples. It aims to capture consumer substitution patterns when relative prices change	The WPI has a broader industry-based framework less focused on consumer habits
The CPI employs rental equivalence approaches for durable goods like housing	The WPI relies more on asset prices even if purchases are infrequent.
CPI filters out product quality changes to isolate pure price movements	The WPI makes relatively limited quality adjustments, contributing to greater monthly volatility.
CPI trying to capture consumer prices mid-month	WPI samples attempt to reflect prices at the start of each month when contracts are negotiated.