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Understanding Consumer Price Index (CPI)

2021-06-11 15:45:02


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, unemployed, people whose incomes are below the federal poverty threshold, and retired people in the country but excludes non-metro or rural populations, farm families, armed forces, people who are currently incarcerated, 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.

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. While it does measure the variation in price for retail goods and other items paid by consumers, the Consumer Price Index does not include things like savings and investments, and can often exclude spending by foreign visitors.

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.

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.

Risk WarningThe above content is for reference only, and does not represent JRFX’s position. JRFX does not assume any form of loss caused by any trading carried out in accordance with this article. Please consult your financial planner for your investment portfolios and manage your own risk.

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