The Consumer Price Index, or CPI, is, in short, the change in prices that people pay for goods and services over a specified period of time. Read on to learn the details.
The Consumer Price Index, or CPI, measures the rise or fall in prices for things purchased by a ‘consumer’, usually considered to be someone buying on the retail market. More specifically, CPI utilizes a weighted average of prices for a set (or ‘basket’) of goods and services. CPI covers a broad spectrum of items, but sub-indices often exclude categories of goods to sharpen the focus.
CPI is calculated by taking price changes for each item in a predetermined basket of goods and averaging them based on their relative weight in the whole basket. The prices in consideration are the retail prices of each item, as available for purchase by individuals.
Why is a weighted average used when calculating CPI? In general, a weighted average takes into account the relative importance of the elements in a data set. If these importances are correctly set, a weighted average is more accurate than a simple average with all of the elements having the same weight. The weights don’t stay the same, as the spending habits of consumers changes, and this needs to be reflected. For example, the weights had to be changed as the COVID epidemic took hold and consumers started spending a lot more on health care.
CPI under the microscope
The U.S. Bureau of Labor Statistics (BLS) releases a monthly CPI report covering the last month. Along with the overall CPI figure, there is also a ‘core CPI’ figure. This measure removes food and energy prices, and thus offers a more stable reading on inflation. Food and energy prices are more susceptible to sizable and unpredictable changes that have little to do with consumer demand.
Changes in CPI point to changes in the cost of living, making it central to identifying periods of inflation or deflation.
CPI is watched closely by economists as well as businesses. If inflation, as seen in CPI, is deemed to be too high or too low, the Federal Reserve might change the prime lending rate, which will affect lending to both businesses and individuals. The market’s expectations for CPI in particular can affect the prices of equities as well as sentiment and short-to-mid term planning for businesses.
