The Consumer Price Index (CPI) is a measure of inflation in an economy, calculated using two formulas for single items or a basket of goods. Economists choose a base year and weight each item in the basket to accurately represent an individual’s needs.
The Consumer Price Index (CPI) is a standard calculation for determining inflation in a nation’s economy. It is one of the most commonly calculated and reported economic measures that economists use to judge the health and strength of the economy. The CPI calculation has two different formulas, one for a single item and one for a group of items. The monthly CPI figure reported through the news is generally the latter formula, representing a basket of goods most often purchased by all consumers. Each formula divides the current price for each item by a base year and multiplies the result by 100 to get an inflation percentage; calculating the CPI for multiple commodities may involve weighting each item in the basket of commodities.
Economists often choose a base year to start their CPI calculations. This year doesn’t always matter, though it must stay the same for each subsequent year for the formula to make sense. For example, economists may agree that 1984 is a good starting point for calculating the CPI. The base year price for each asset in the CPI formula, therefore, will use the price of each asset starting this year. Adjustments or modifications may be necessary to perform inflation measurements over a longer period of time.
Calculating CPI for a single item is quite simple. Economists simply divide the current year’s price by the base period price for the item and then multiply the result by 100. The result is a percentage of inflation that economists argue has raised the price of that item. For example, a 2.1 percent increase in the price of a gallon of milk is a common response for a single CPI calculation. The bigger problem, however, is that the calculation doesn’t necessarily indicate why the price has risen.
The notional basket of goods in calculating the CPI is a little more involved. Economists must select a group of items—such as food, housing, clothing, vehicles, medical care, and other goods—that accurately represent an individual’s needs to maintain a standard of living. Weighting each item can be difficult; for example, economists may weight housing by 40 percent, food by 18 percent, and medical care by 9 percent, with the other items making up the remainder. The CPI calculation is the same as the previous formula for each individual item, with the answer multiplied by the weight factor for the basket of goods. Adding up the final data gives a calculation of total inflation which should represent the amount of inflation in the current market.
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