Consumer price index

A consumer price index (CPI) is a statistical estimate of the level of prices of goods and services bought for consumption purposes by households. It is calculated as the weighted average price of a market basket of consumer goods and services. Changes in CPI track changes in prices over time. The items in the basket are updated periodically to reflect changes in consumer spending habits. The prices of the goods and services in the basket are collected (often monthly) from a sample of retail and service establishments. The prices are then adjusted for changes in quality or features.^{[citation needed]} Changes in the CPI can be used to track inflation over time and to compare inflation rates between different countries. While the CPI is not a perfect measure of inflation or the cost of living, it is a useful tool for tracking these economic indicators. It is one of several price indices calculated by many national statistical agencies.

A CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. Sub-indices and sub-sub-indices can be computed for different categories and sub-categories of goods and services, which are combined to produce the overall index with weights reflecting their shares in the total of the consumer expenditures covered by the index. The annual percentage change in the CPI is used as a measure of inflation. A CPI can be used to index (i.e., adjust for the effect of inflation) the real value of wages, salaries, and pensions; to regulate prices; and to deflate monetary magnitudes to show changes in real values. In most countries, the CPI is one of the most closely watched national economic statistics.

The index is usually computed monthly, or quarterly in some countries, as a weighted average of sub-indices for different components of consumer expenditure, such as food, housing, shoes, and clothing, each of which is, in turn, a weighted average of sub-sub-indices. At the most detailed level, the elementary aggregate level (for example, men's shirts sold in department stores in San Francisco), detailed weighting information is unavailable, so indices are computed using an unweighted arithmetic or geometric mean of the prices of the sampled products. (However, the growing use of barcode scanner data is gradually making weighting information available even at the most detailed level.) These indices compare prices each month with prices in the price-reference month. The weights used to combine them into the higher-level aggregates and then into the overall index relate to the estimated expenditures during the preceding whole year of the consumers covered by the index on the products within its scope in the area covered. Thus, the index is a fixed-weight index but rarely a true Laspeyres index since the weight-reference period of a year and the price-reference period, usually a more recent single month, do not coincide.

Ideally, all price revalidations are accepted, and the weights would relate to the composition of expenditure during the time between the price-reference month and the current month. There is a large technical economics literature on index formulas that would approximate this and that can be shown to approximate what economic theorists call a true cost-of-living index. Such an index would show how consumer expenditure would have to move to compensate for price changes so as to allow consumers to maintain a constant standard of living. Approximations can only be computed retrospectively, whereas the index has to appear monthly and, preferably, quite soon. Nevertheless, in some countries, notably the United States and Sweden, the philosophy of the index is that it is inspired by and approximates the notion of a true cost of living (constant utility) index, whereas in most of Europe it is regarded more pragmatically.

The coverage of the index may be limited. Consumers' expenditure abroad is usually excluded; visitors' expenditure within the country may be excluded in principle if not in practice; the rural population may or may not be included; certain groups, such as the very rich or the very poor, may be excluded. Savings and investment are always excluded, though the prices paid for financial services provided by financial intermediaries may be included along with insurance.

The index reference period, usually called the base year, often differs both from the weight-reference period and the price-reference period. This is just a matter of rescaling the whole time series to make the value for the index reference period equal to 100. Annually revised weights are a desirable but expensive feature of an index; the older the weights, the greater the divergence between the current expenditure pattern and that of the weight reference period.

It is calculated and reported on a per region or country basis on a monthly and annual basis. International organizations like the Organisation for Economic Co-operation and Development (OECD) report statistical figures like the consumer price index for many of its member countries. In the US the CPI is usually reported by the Bureau of Labor Statistics.

An English economist by the name of Joseph Lowe first proposed the theory of price basket index in 1822. His fixed basket approach was relatively simple as Lowe computed the price of a list of goods in period 0 and compared the price of that same basket of goods in period 1. Since his proposed theories however were elementary, later economists built on his ideas to form our modern definition.