Consumer Price Index (CPI)
By Jason Fernando Reviewed By Peter Westfall Updated Dec 15, 2020 Table of Contents
- What Is the Consumer Price Index?
- Understanding Consumer Price Index (CPI)
- How is CPI Used
- Who and What Are Covered?
- Calculating CPI
- Types of CPI
- CPI Regional Data
- Frequently Asked Questions
What is Consumer Price Index (CPI)?
The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living. The CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. 1:49
The Consumer Price Index
Understanding Consumer Price Index (CPI)
The CPI measures the average change in prices over time that consumers pay for a basket of goods and services, commonly known as inflation. Essentially it attempts to quantify the aggregate price level in an economy and thus measure the purchasing power of a country’s unit of currency. The weighted average of the prices of goods and services that approximates an individual’s consumption patterns is used to calculate CPI. A trimmed mean may be used as part of this.
The U.S. Bureau of Labor Statistics (BLS) reports the CPI on a monthly basis and has calculated it as far back as 1913. It is based upon the index average for the period from 1982 through 1984 (inclusive) which was set to 100. So a CPI reading of 100 means that inflation is back to the level that it was in 1984 while readings of 175 and 225 would indicate a rise in the inflation level of 75% and 125% respectively. The quoted inflation rate is actually the change in the index from the prior period, whether it is monthly, quarterly or yearly.
While it does measure the variation in price for retail goods and other items paid by consumers, it does not include things like savings and investments, and can often exclude spending by foreign visitors.
Key Takeaways
- The Consumer Price Index measures the average change in prices over time that consumers pay for a basket of goods and services.
- CPI is the most widely used measure of inflation and, by proxy, of the effectiveness of the government’s economic policy.
- The CPI statistics cover professionals, self-employed, poor, unemployed and retired people in the country but excludes non-metro or rural populations, farm families, armed forces, people serving in prison and those in mental hospitals.
- CPI-W measures the Consumer Price Index for Urban Wage Earners and Clerical Workers while the CPI-U is the Consumer Price Index for Urban Consumers.
How is CPI Used?
CPI is an economic indicator. It is the most widely used measure of inflation and, by proxy, of the effectiveness of the government’s economic policy. The CPI gives the government, businesses, and citizens an idea about prices changes in the economy, and can act as a guide in order to make informed decisions about the economy.
The CPI and the components that make it up can also be used as a deflator for other economic indicators, including retail sales, hourly/weekly earnings. Additionally, it can be used to value a consumer’s dollar to find its purchasing power. Generally, the dollar’s purchasing power declines when the aggregate price level increases and vice versa.
The index can also be used to adjust people’s eligibility levels for certain types of government assistance including Social Security and it automatically provides the cost-of-living wage adjustments to domestic workers. According to the BLS, the cost-of-living adjustments of more than 50 million people on Social Security, as well as military and Federal Civil Services retirees are linked to the CPI.
Who and What Are Covered?
The CPI statistics cover professionals, self-employed, poor, unemployed and retired people in the country. People not included in the report are non-metro or rural populations, farm families, armed forces, people serving in prison and those in mental hospitals.
The CPI represents the cost of a basket of goods and services across the country on a monthly basis. Those goods and services are broken into eight major groups:
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The BLS includes sales and excise taxes in the CPI — or those that are directly associated with the price of consumer goods and services — but excludes others that aren’t linked such as income and Social Security taxes. It also excludes investments (stocks, bonds, etc.), life insurance, real estate and other items unrelated to consumers’ day-to-day consumption.
Calculating CPI
The BLS records about 80,000 items each month by calling or visiting retail stores, service establishments (such as cable providers, airlines, car and truck rental agencies), rental units and doctors’ offices across the country in order to get the best outlook for the CPI.
The formula used to calculate the Consumer Price Index for a single item is as follows:
CPI= Cost of Market Basket in Given YearCost of Market Basket in Base Year×100\text{CPI}=\frac{\text{ Cost of Market Basket in Given Year}}{\text{Cost of Market Basket in Base Year}}\times100CPI=Cost of Market Basket in Base Year
Cost of Market Basket in Given Year×100
The base year is determined by the BLS. CPI data for the years 2017 and 2018 were based on surveys collected in 2014 and 2015.
Types of CPI
Two types of CPIs are reported each time.
- The CPI-W measures the Consumer Price Index for Urban Wage Earners and Clerical Workers. Between 1913 and 1977, the BLS focused on measuring this type of CPI. It was based on households whose incomes comprised of more than one-half from clerical or wage occupations, and in which at least one of the earners were employed for at least 37 weeks during the previous 12-month cycle. The CPI-W primarily reflects changes in the costs of benefits paid to those on Social Security. This measurement of CPI represents at least 28 percent of the country’s population.
- The CPI-U is the Consumer Price Index for Urban Consumers. It accounts for 88 percent of the U.S. population and is the better representation of the general public. The BLS made improvements to CPI in 1978 and introduced a broader target population. This type of CPI is based on the spending of almost all the population that resides in urban or metropolitan areas and includes professionals, self-employed workers, those living below the poverty line, unemployed, and retired people. It also includes urban wage earners and clerical workers.
Despite introducing the CPI-U in 1978, the BLS continued to measure the traditional measure of the CPI-W. But since 1985, the main difference between the two indexes has been the expenditure weights assigned to item categories and geographic areas.
CPI Regional Data
The Bureau of Labor Statistics also breaks down the CPI based on regions. Each month, the report is broken out into the four major Census regions:
- Northeast
- Midwest
- South
- West.
Three major metro areas are also broken out each month. The regions are
- Chicago-Gary-Kenosha
- Los Angeles-Riverside-Orange County
- New York-Northern NJ-Long Island.
Along with the regional information provided each month, the Bureau of Labor Statistics also publishes reports for 11 additional metro areas every other month and an additional 13 metro areas semi-annually. These reports cover areas with large populations and represent a particular regional subset.
To learn how to take advantage of inflation, read How to Profit From Inflation and The Consumer Price Index: A Friend to Investors.
Frequently Asked Questions
What is the Consumer Price Index (CPI)?
The CPI is a statistical measure prepared by the Bureau of Labor Statistics (BLS). It is one of the most commonly cited economic statistics, and is widely used as a proxy for inflation. Investors pay close attention to CPI as an indicator of where the economy is headed, influencing price forecasts for inflation-sensitive assets such as bonds and commodities. Among the general public, CPI is often seen as a barometer of overall economic health, with most commentators preferring low to moderate CPI in the 2-3% range.
How is the CPI calculated?
CPI is the weighted-average price of a broad cross-section of goods and services. This collection of items, often referred to as the CPI’s “basket” of goods, is intended to mimic the typical products and services purchased by American consumers. Over the years, as the prices of those products rise due to inflation, this gradual increase is reflected in a rising CPI. In the media, CPI is commonly referred to in terms of its percentage year-over-year change.
What are some criticisms of the CPI?
Some have argued that the CPI fails to capture the regional variations in prices, as well as the different buying patterns of particular groups of Americans. For example, Americans living in expensive areas such as New York City or San Francisco may have significantly different spending patterns as compared to those living in rural or suburban areas. Another common criticism of CPI is that it understates the rate of inflation by failing to adequately reflect certain types of expenditures. For instance, the CPI includes out-of-pocket medical expenses but does not fully reflect the portion of medical expenses borne by insurance companies and government healthcare programs.
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Producer Price Index (PPI)
By Christina Majaski Updated Dec 23, 2020
What Is the Producer Price Index (PPI)?
The producer price index (PPI), published by the Bureau of Labor Statistics (BLS), is a group of indices that calculates and represents the average movement in selling prices from domestic production over time.
Key Takeaways
- The PPI is different from the CPI in that it measures costs from the viewpoint of industries that make the products whereas the CPI measure prices from the perspective of consumers.
- The BLS separates PPI data into three main areas of classification namely industry, commodity, and commodity-based final and intermediate demand (FD-ID).
- The PPI is considered an objective tool for adjusting prices in long-term purchasing agreements.
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Producer Price Index (PPI)
Understanding Producer Price Index (PPI)
The PPI measures price movements from the seller’s point of view. Conversely, the consumer price index (CPI) measures cost changes from the viewpoint of the consumer. In other words, this index tracks change to the cost of production. There are three areas of PPI classification that use the same pool of data from the Bureau of Labor Statistics: industry, commodity, and commodity-based final and intermediate demand (FD-ID).1
The Bureau of Labor Statistics (BLS) releases monthly information that includes the measurement of nearly 10,000 individual products and product groups.2 This data contains almost all industries that produce goods in the United States. Some of the sectors covered include construction, agriculture, manufacturing, and mining.
Until 1978, the PPI was known as the wholesale price index (WPI). In 1982, the BLS reset all producer price index bases to 100, and this event became the base year.
Each specific measurement period, product group, or individual product type, begins with a base period number of 100. As production increases or decreases, the movements can then be compared against the base number.3 As an example, say the production of balloons has a PPI of 115 for the month of July. The 115 figure indicates that it cost the balloon manufacturing industry 15% more to produce balloons in July than it did in June.
Example of Producer Price Index (PPI)
Businesses often enter into long-term contracts with suppliers. Because prices fluctuate over time, such long-term deals would be difficult with only a single, fixed price for the goods or supplies. Instead, the purchasing business and the supplier typically include a clause in the contract that adjusts the cost by external indicators, such as the PPI.
For example, Company A might get a key component for its widgets from Industry Z. At the outset of the deal, the cost of that component is $1, but they include a provision in the contract that the price will be adjusted quarterly, according to the PPI. So, three months after the contract is signed, the cost of the component could be $1.02 each or $0.99 each, depending on whether or not the PPI went up or down and how much it changed.
Special Considerations: Bureau of Labor Statistics Released Data
BLS produces thousands of product price indexes each month. An analyst can review information broken into three large categories and then further drill down to specific products or services.1
Industry Level Classification
One of the classifications for BLS data is the industry-based category. The industry-based group measures the cost of production at the industry level. It tracks the changes in prices received for an industry’s output outside the sector itself by calculating industry net output. BLS product price index includes over 535 industry-specific listings. Publications include over 4,000 product-related indexes. Further, the agency offers around 600 indexes for grouped industry information.
Commodity Classification
The second category is the commodity classification. This publication ignores the industry of production and combines goods and services by similarity and product make-up. More than 3,700 indexes cover produced goods and about 800 cover services. The indices are arranged by end-use, product, and service.
Commodity-Based Final Demand-Intermediate Demand (FD-ID)
The FD-ID system regroups commodity indexes for goods, services, and construction into sub-product classes, which take into account the specific buyer of the products. The end-user or buyer is termed as either the final demand (FD) or the intermediate demand (ID) user. This classification considers the physical assembly and processing required for these goods. Here, BLS publishes over 600 FD-ID targeted indexes. Some indices are adjusted for seasonality.
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What are Price Indices?
A price index (PI) is a measure of how prices change over a period of time, or in other words, it is a way to measure inflation. There are multiple methods on how to calculate inflation (or deflation). In this guide we will take a look at a couple of methods on how to do so. Inflation is one of the core metrics monitored by the FED in order to set interest rates.
The general formula for the price index is the following:
PI1,2 = f(P1,P2,X)
Where:
- PI1,2: Some PI that measures the change in price from period 1 to period 2
- P1: Price of goods in period 1
- P2: Price of goods in period 2
- X: Weights (the weights are used in conjunction with the prices)
- f: General function
Laspeyres Price Index
Ernst Louis Etienne Laspeyres (1834-1913) was a German economist and statistician. Laspeyres’s main contribution to economics and statistics was his work on index numbers and calculating inflation. The formula for Laspeyres Price Index is as follows:
Where:
- PiB: The price of good i in the Base period
- PiF: The price of good i in the Final period
- QiB: The quantity consumed of good i in the Base period
- QiF: The quantity consumed of good i in the Final period
The Laspeyres PI weighs prices (both Base period prices and Final period prices) with base period quantities. Consider an economy with N goods and services. The numerator in the Laspeyres price index calculates nominal expenditure required to consume base period quantity at final period prices. The denominator calculates nominal GDP in the base period.
Paasche Price Index
Hermann Paasche (1851-1925) was a German economist and statistician. Paasche’s main contribution to economics and statistics was his work on wage inflation.
The formula for the Paasche Price Index is as follows:
Where:
- PiB: The price of good i in the Base period
- PiF: The price of good i in the Final period
- QiB: The quantity consumed of good i in the Base period
- QiF: The quantity consumed of good i in the Final period
Paasche PI weighs prices (both Base period prices and Final period prices) with Final period quantities. Consider an economy with N goods and services. The numerator calculates nominal GDP in the Final period. The denominator in the price index calculates nominal expenditure required to consume Final period quantities at Base period prices.
Marshall-Edgeworth Index
Alfred Marshall (1842-1924) was an English economist who is widely considered to be the father of modern neoclassical economics. Marshall’s book, Principles of Economics (1890), is one of the most influential textbooks in the history of economic thought. Francis Ysidro Edgeworth (1845-1926) was an Anglo-Irish economist and philosopher. Edgeworth was one of the earliest proponents of using statistics to analyze economic questions.
The formula for the Marshall-Edgeworth Price Index is as follows:
Where:
- L(P): The Laspeyres Price Index
- P(P): The Paasche Price Index
The Marshall-Edgeworth Price Index is the arithmetic mean (simple average) of the Laspeyres Price Index and the Paasche Price Index.
Fisher Price Index
Irving Fisher (1867-1947) was an American economist and statistician. Fisher was one of the earliest neoclassical economists in the US and is known as the first econometrician (application of linear regression to economic theory). The American worked on many areas of economics, including trade, monetary theory, and inflation measurement.
The formula for the Fisher Price Index is as follows:
The Fisher Price Index is the geometric mean of the Laspeyres Price Index and the Paasche Price Index.
Illustrative Example
| Commodity | Base Price (PB) | Base Quantity (QB) | Final Price (PF) | Final Quantity (QF) |
|---|---|---|---|---|
| 1 | 10 | 1000 | 14 | 800 |
| 2 | 12 | 2000 | 16 | 1500 |
| 3 | 30 | 500 | 30 | 450 |
| 4 | 35 | 5000 | 30 | 8000 |
| 5 | 40 | 400 | 45 | 150 |
| 6 | 100 | 350 | 150 | 200 |
| 7 | 2500 | 100 | 2000 | 200 |
| 8 | 55 | 1000 | 50 | 2000 |
| 9 | 10000 | 25 | 10500 | 25 |
| 10 | 25 | 4000 | 40 | 3000 |
| Price Index | Numerical Value |
|---|---|
| Laspeyres Price Index | 1.025806452 |
| Paasche Price Index | 0.943342444 |
| Marshall-Edgeworth Price Index | 0.984574448 |
| Fisher Price Index | 0.983710712 |
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