The Consumer Price Index

Consumer Index Price (CPI) formula

CPI = Price of basket of goods and services in current year / Price of basket in base year X 100

CPI tries to gauge

how much incomes must rise to maintain a constant standard of living.

Inflation is

the ongoing increases in the general level of prices.

If a price index is computed assuming a fixed basket of goods, it ignores

the possibility of consumer substitution and, therefore, overstates the increase in the cost of living from one year to the next.

The Core CPI better reflects

underlying inflation trends

the five steps that the BLS follows

Fix the basket, Find the prices, Compute the basket's cost, Choose a base year and compute the index, Compute the inflation rate

unmeasured quality change

Improvements in the quality of goods in the basket increase the value of each dollar

Computing Inflation Rate from CPI

Inflation rate in year 2 = CPI in year 2 - CPI in year 1 / CPI in year 1 X 100

how do we measure inflation?

One of the oldest and oftentimes most used measurements of inflation is the Consumer Price Index, or the CPI.

the BLS computes the CPI and the inflation rate...

The BLS collects and processes data on the prices of thousands of goods and services every month and, by following the five foregoing steps, determines how quickly the cost of living for the typical consumer is rising.

introduction of new goods

When a new good is introduced, consumers have more variety from which to choose, and this in turn reduces the cost of maintaining the same level of economic well-being

Three problems with the CPI

The substitution bias, the introduction of new items, & quality changes

ow the CPI Is Calculated

When the BLS calculates the CPI and the inflation rate, it uses data on the prices of thousands of goods and services.

Producer Price Index (PPI)

a measure of the cost of a basket of goods and services bought by firms. measures the cost of a basket of goods and services bought by firms rather than consumers.

Core CPI

a measure of the overall cost of consumer goods and services excluding food and energy. Because food and energy prices show substantial short-run volatility, the core CPI better reflects underlying inflation trends.

consumer price index (CPI)

a measure of the overall cost of the goods and services bought by a typical consumer

Substitution bias

consumers may change their purchasing habits away from goods that have increased in price. consumers substitute toward goods that have become relatively less expensive.

The CPI is based on a fixed basket of goods and services, it does not reflect the

increase in the value of the dollar that results from the introduction of new goods.

the Bureau of Labor Statistics (BLS), which is part of

the Department of Labor,