Consumer Price Index Formula: How Much Did You Say It Was?!

consumer price index formulaYou know how prices sometimes go up, then down, then up again? The other day I was shopping for a toothbrush and was shocked to see my favorite brand increase its price by an entire dollar! The price of goods does have a tendency to rise and fall. One formula that monitors this is called the Consumer Price index. The Consumer Price Index (CPI) formula, also known as the Retail Price Index (RPI), is a formula in economics that measures the decrease or the increase in the price of goods. For economists, this formula is useful since it lets them see which price groups are moving down or up. Plus, it also helps them find out the reasons behind the change. From one country to the next, the Consumer Price Index Formula may vary since the measured goods vary depending on how important it is in the local market place.

Want to learn more? Here is a course called Economics Without Boundaries with David McWilliams, who happens to have twenty five years of economic experience to share with you.

To construct the CPI, two basic data types are needed: the weighting data and the price data. The weighting data is the estimate of different expenditure types’ shares in the total covered expenditure of the index. The price data is collected from a services and goods sample from a sales outlet sample in a location sample at a given time. Usually, the weights are based on the data expenditure taken from the expenses surveys of a household sample. Even if some of the items samples are done using methods that involve probabilistic sampling and frame methods, a lot of the outlets and items are selected in a way that is just common sense, also known as sampling that is purposive. By the way, here is a course called Capitalism in Crisis: The Global Economic Crisis Explained which you might be interested in.

The CPI Formula

It is fairly simple to calculate the CPI. All that happens is that in a market basket of goods, the individual items are calculated for changes in price for each item and gets the average in per cent. This figure represents the price decrease or the price increase. A base year for calculations is used by the CPI which is usually between ’82 and ’84. From these years to present day, the price increases are calculated. Usually, each item is weighed depending on how important it is in the marketplace. For example, food is a necessity so this weighs higher than luxury goods.

  • CPI Formula for Multiple Items:

Example: What is the price of 90,000 items from 23,000 rental units and 36,000 stores are averaged after being added together? These get weighted in this way:

41.4% = Housing

17.4% = Food and Beverage

17% = Beverage

6.9% – Medical Care

6.9% = Other

6% = Apparel

4.4 % = Entertainment

43% = Taxes (not included in the computation for CPI)

The formula is:

y

  • CPI Formula for 1 Item:

For just one item, the CPI formula is:

(price on base year) x (CPI Current)/ (CPI on Base Year) = Current Item Price in $ or:

Price 2             CPI 2

———–   =   ————

Price 1             CPI 1

Where CP is usually an index of 100 and 1 I usually the comparison year.

You can also calculate for CPI for a single item by using the formula:

CPI = updated cost/base period cost x 100. The ‘updated cost’ (or the price of bread in 2010 or the price of an item at certain years) is divided by the base year (i.e. the price of bread in 1983) and multiplied by 100.

A Goods Market Basket

Depending on the country, a market basket of goods varies. This also depends on what goods consumed are most important in the current environment of the economy. In the United States, goods are put into categories such as services, energy, housing, personal goods, leisure goods and household goods. In each category, individual items are usually the most important ones, such as home prices, heating oil, gasoline, clothing and food.

Limitations of CPI

The Consumer Price Index is a convenient method of calculating the price level and cost of living for a certain time period. However, CPI does not exactly provide a totally accurate estimate for the cost of living. Issues such as changes in quality, introducing new products and substituting bias, which is when consumers substitute one good for another and all of this does affect CPI accuracy. Inflation can also be overstated by CPI since it does not always account for new services and goods or quality improvements.

On a Month to Month Basis

The Consumer Price Index Formula, commonly called the Retail Price Index is a measurement of inflation that is utilized to find out the increase in price in a basket of market goods. The US Bureau of Labor Statistics measures this number on a month to month basis. For economists, this is actually a barometer to use when trying to find out if in the economy, inflation or deflation is happening. While the market basket of goods is the basis on which the calculation is made, it also calculates which prices or groups are decreasing or increasing, such as durable goods, food or energy. Here is an article you might be interested in entitled The International Business Environment is Here to Stay.

Inflation in the Free Market

It is believed by many economists that in the free market system, inflation is always present. Since most economies are expanding continuously, inflation exists and the growth that results increases the consumer goods’ cost. However, this inflation will decrease slowly because the price of goods becomes lower with increase in supply. Since goods are now cheaper to buy, demand then decreases. Here is a course entitled How the Economy Really Works that helps you understand how the government manages the economy in the 21st century.

Government policy is another reason for inflation. If the free market is infused with money by the government, the increase in dollars leads to fewer goods being chased by more money. Until the government reduces the money amount in the market system, this inflation will not be reduced. Here is a course entitled International Trade and the New Geographic Economy that Paul Krugman, who won the Laureate of Nobel Prize in Economics in 2008, offers.