What Is CPI?

The consumer price index (CPI) is a measure used to assess price changes associated with the cost of living. CPI tracks changes in the price level of a basket of consumer goods and services. It is one of the most commonly used indicators of inflation, which refers to the rate at which the general level of prices for goods and services rises, eroding purchasing power.

How Does CPI Work?

CPI is calculated by national statistical agencies, like the Bureau of Labor Statistics (BLS) in the United States. Let’s see how it typically works.

1. Selection of goods and services

A representative basket of goods and services is selected. This basket includes items that are commonly purchased by households, such as food, clothing, transportation, medical care, and entertainment. The selection aims to reflect the spending habits of the average consumer.

2. Data collection

Prices for the items in the basket are collected periodically. This data is gathered from various sources, including retail stores, service providers, and online platforms. The prices are recorded in different regions to account for geographic variation.

3. Weighting

Each item in the basket is assigned a weight based on its importance in the average consumer's budget. For example, if consumers spend more on housing than on entertainment, housing will have a higher weight in the index.

4. Calculation of the index

The prices of the items in the basket are compared to a base period, and the index is calculated. The base period is usually set to 100, and the CPI value for subsequent periods shows the percentage change in prices relative to this base period. For example, a CPI of 105 indicates a 5% increase in prices since the base period.