What is Consumer Price Index (CPI)?
The consumer price index is an economic indicator and a measure of
inflation. It is the weighted average increase in the household expense every
month in each fiscal year. The household expense includes a basket of goods and
services such as food and beverages, rental expense, education, entertainment,
transportation, clothes, other essential services such as haircut, etc. CPI is
calculated by aggregating the price change of all the household expenses as compared
to the base year and averaging them.
To be specific, the price change for every item is calculated in the
following way, each item in the basket is assigned a different weight depending
upon many economic factors and later multiplied with the price change of that
particular goods and service. In other words, the CPI index denotes the average
price change in the goods and services over time. For example, if the weighted
average price of consumer goods and services for the year 2008 is $100, while
in 2009 the same goods and services are worth $120, then, in this case, the net
CPI is 20%.
A snapshot of the actual Consumer Price Index (Source: U.S. Bureau of Labor Statistics)
Effect of CPI on Purchasing Power:
The consumer’s purchasing power increases
when the aggregate price level decreases and vice versa. In other words, the value
of the dollar falls in case the price of goods and services increase.
A large rise in the CPI levels in a very short period of time is called a
period of inflation whereas a large drop in the CPI levels is termed as a period
of deflation. If the CPI index is under control then it is believed that
the economy will do good and we can expect good returns from the Stock market.
(To know more about the stock market, refer our most popular article: Basics of Stock Market)
FYI, when the inflation rate is much more than the expected rate, for
example, a 14% increase in inflation indicates a hyperinflation situation. (We
will know much about hyperinflation in our next post, so stay tuned)
Who is responsible to control inflation?
It is the responsibility of the Central Bank (E.g. RBI, in case of India)
and the government to keep inflation levels under control and thus they come up
with different economic policies which also includes creating a limit for CPI
inflation every year, where the goal is to keep the inflation between the said
limits. For example, In India, the increase in the CPI index should be between
2% to 6%. More than 6% indicate that Inflation is more than expected and it
creates a negative impact on the economy. Even inflation of less than 2% gives
a negative impact as it is believed that the companies are not able to increase
the prices of their goods because the consumers are not having sufficient
purchasing power and they are not ready to spend more, hence the prices are
reduced because of low demand.
CPI calculation formula (for single item)
Who calculates CPI?
CPI index is nothing but the household expenses inflation, however, it
is important to monitor this index regularly and hence there are some international
organisations like “Organisation for economic co-operation and development” who
are responsible for reporting the CPI figures (monthly, quarterly or annually)
for many of its member countries. For instance, in the United States, the CPI
figures are calculated by “Bureau of economic analysis” and in India, the CPI
is calculated by “Ministry of statistics and programme and implementation”
CPI is one of the most important and closely watched national economic
indicators. It is an ideal tool for calculating actual inflation figures at a
consumer level and most importantly it is accepted all over the world.
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