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What is the Consumer Price Index?

Read about how CPI is calculated and how it is used to maintain the economy!

The Consumer Price Index is a monthly measure of the average prices of a predetermined basket of goods and services over a period of time. It is used to measure and report if a country’s economy is experiencing any inflation or deflation. The consumer price index is also a way to evaluate how the cost of living in an economy fluctuates.

How to Calculate the Consumer Price Index

In the United States, the Bureau of Labor Statistics calculates the Consumer Price Index or CPI. They take the average cost of a predetermined cost of goods for a month and then divide it by the average cost of the same basket of goods from the previous month. They then multiply the result by 100 to get the CPI.

The goods and services used in the measurement of the CPI include the costs of food, energy (oil and gasoline), commodities (medication, clothing), health care, transportation, housing, education, recreation, and other expenses. The CPI essentially measures the purchasing power of the country’s currency by computing the economy’s average price level.

It reflects the purchasing habits of a country’s population. All residents, including working professionals, self-employed people, retired people, and the unemployed, are included in the CPI calculations.

However, the CPI does not include savings, investments, and foreign or tourist spending in the basket.

Uses of CPI

The United States Federal Reserve monitors the consumer price index in order to maintain stability in the economy. It uses the CPI to detect if there is any inflation or deflation and uses monetary policies to mediate.

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The biggest benefit that CPI provides is measuring the rate of inflation. Inflation is the biggest threat an economy can face. Inflation increases the costs of living, which, in turn, lowers the economy’s standards of living also. An economy facing inflation means all goods and services cost more. This means manufacturers produce in fewer quantities, which could equal a higher unemployment rate. The CPI lets the government monitor and prepare for factors like these.

Other uses of CPI  include the Census Bureau, which uses CPI to regulate the poverty threshold. The poverty threshold is the minimum level of income adequate for living. The Census Bureau uses the CPI to adjust wages depending on inflation or deflation. The Social Security Administration also uses it to calculate and adjust the benefits paid to Supplement Security Income and Social Security receivers.

Controversy Surrounding CPI

The Consumer Price Index has gone through lots of controversies over whether CPI downplays or exaggerates inflation levels. Many economists have differing opinions on how to measure CPI and how they shoud use it to prepare for inflation or deflation in the economy.

To get a more accurate understanding of inflation rates in a country, they believe that people should consider many other measurements like the Producer Price Index, Personal Consumption Expenditure, and Gross Domestic Product deflator along with the CPI in order to monitor and regulate inflation.

Written By

Travis Barnett is an expert in finances backed by 10 years of experience as a financial analyst at CNB. He graduated from UCLA's Anderson School of Management in 2010 and has been in the field ever since. Travis now enjoys sharing his business experience with others as a financial writer in San Diego. In his spare time, he enjoys hitting the links and working on his golf swing.

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