Everything You Need to Know About the Consumer Price Index (CPI)

Most children learn about inflation by listening to stories about how an item or service used to cost less back in the day. For instance, their parents can tell them that going to the movies cost a quarter when they were younger, compared to how costly a similar service is today.

The market is continuously evolving with rapid changes in prices for products and services; however, we can all agree that items have more costly while as the dollar’s purchasing power steadily declines. Chances are that you’ve noticed when buying groceries or paying your bills.

Often, most individuals look at the receipt after grocery shopping to check the damage. Maybe you look for an increase in prices on items that you’re familiar with. Simply put, this is what the US government does. The government checks changes in prices for consumers throughout the country using the consumer price index.

If you are here, you want to understand the consumer price index and why it matters. This article provides you with all the necessary details to understand the CPI as an economic metric tool and its use.

What is CPI (or the Consumer Price Index)

The CPI (or Consumer Price Index) helps the BLS measure the average price changes in products or services in the market basket as paid for by consumers over time. We can also explain it as measuring the aggregate price level for services and goods in an economy. It consists of a collective list of commonly purchased services and goods.

The CPI measures changes in purchasing power of a specific country’s currency and a basket of services and goods’ price level. The market basket used when calculating the CPI represents an economy’s consumption expenditure and is a weighted average representing pricing for services and products.

Simply put, the CPI indicates a typical consumer’s cost of living; however, it is not a thorough measurement of living costs. Typically, CPI is used to measure and identify periods of deflation and inflation for consumers regarding their daily living expenses.

Instances of inflation cause goods and services to cost more. These periods are marked by a rise in CPI over a short window, i.e., six to eight months. Periods of deflation are characterized by a steady decline in prices for services and products. The Consumer Price Index is calculated, analyzed, and presented monthly by the BLS (Bureau of Labor Statistics). The BLS is part of the Department of Labor as a sub-agency.

What are the Consumer Price Index’s applications?

The CPI calculates price deviations, which can go down or up for average consumers. As such, the CPI can adjust incomes for various groups of individuals.

For instance, collective bargaining agreements cover over 2M US workers. These agreements tie the workers’ wages to the Consumer Price Index. Changes in the CPI affect their wages such that their salaries can be increased if the CPI goes up.

Additionally, the Consumer Price Index affects individuals with Social Security. For instance, 47.8 million beneficiaries of the Social Security program get adjustable income increments depending on the CPI.

Millions of Federal Civil Service, survivors, and military retirees receive benefits related to the CPI and close to 22 million individuals on food stamps. Changes in the Consumer Price Index also affect lunch costs for more than 27 million students that have lunch in school.

Individuals and private establishments also use the Consumer Price Index to keep royalties, rents, child support, and alimony compensations in line with price shifts. The Federal government has also used the Consumer Price Index to adjust federal income taxes and avoid inflation-induced tax increments.

What type of information do governments collect for the Consumer Price Index?

The federal government seeks to understand how much Americans pay for products and services and what they buy. To do this, the government (through the BLS) collects and analyzes data from individuals and families on items they often purchase.

Over 7000 families give information about spending habits in the US quarterly allowing the government to analyze the statistics and develop the consumer price index. Additionally, 7000 more families keep diaries and list everything they’ve bought within two weeks.

Which group of the population is involved with CPI measurements?

Not all citizens are included within the CPI measurements. The CPI measurements involve spending patterns of three groups of the population: clerical workers, urban wage earners, and all urban consumers. As stated in the BLS’ monthly report, all urban consumers represent 87% of the US total population.

Individuals studied include the unemployed, self-employed, retired, and the poor. The studies also include clerical workers and city wage earners. Groups excluded from the survey have farm families, people living in rural areas, psychiatric institutions, prisons, and those in the armed forces.

The fact that CPI studies ignore individuals in the groups mentioned above leads many analysts to argue that its results don’t represent an actual decrease or increase in price measurement.

What services and goods do the BLS analyze?

According to the Bureau of Labor and Statistics, the CPI measurements include changes in costs for:

• Medical care, including medical supplies, prescription drugs, hospital services, eye care, eyeglasses, physician services, etc.
• Recreation items including toys, television, pets, sports equipment, pet products, pets, and admissions
• Cloths, including women’s and men’s clothes, jewellery, and sweaters
• Transportation including airline fares, new vehicles, automotive insurance, and acquiring new vehicles
• Education and communication, including postage, college tuition, computer software, accessories, and telephone services
• Other goods include smoking products, personal services, tobacco, and funeral expenses.

Other things included in the groups above include sewerage and water charges, vehicle tolls, and automatic registration charges. The CPI also includes excise taxes and sales involved with purchases.

The CPI results exclude various taxes, including social security and income taxes, since they aren’t directly associated with purchasing consumer services and goods. Another item that’s not on the list is investments, including bonds, stocks, life insurance, and real estate. The BLS assigns several hundred researchers and sends them to doctor’s offices, retail establishments, and rental properties across the country to get the necessary information.

Uses of the CPI

The CPI serves as an economic indicator and as a measure of indication for inflation on the end user. The CPI can be used to understand a country’s currency’s purchasing power. Governments can also use it to measure the effectiveness of the government’s economic policies.

The CPI can also adjust various economic indicators like price changes. For instance, the government can adapt components of a nation’s income using CPI.

The CPI can also be used to make the cost of living adjustments for social security beneficiaries and prevent inflation-induced tax increments.

Limitations of the CPI

Limitations of the CPI include:

• Sampling errors. For instance, there could be instances where the correct samples aren’t chosen and, as such, cannot represent an entire population.
• Non-sampling errors, including those associated with operational implementation and price-data collection.

Why is the CPI recognized by most as a reliable cost-of-living metric?

According to the BLS, governments use a cost-of-living index to record and analyze changes in how much the consumer needs to pay to achieve a specific standard of living over time. Living standards can include environmental or governmental factors affecting a consumer’s well-being. They have health, education, crime, safety, water quality, etc. The CPI doesn’t measure these items, and no other federal government entity does.

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