What is involved in calculating the CPI?

Economists calculate the rate of price increase by comparing the current costs of goods with those of an established base year.

The consumer price index (CPI) is a standard calculation for determining inflation in a country’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 value reported through news outlets is usually the latter formula, which represents a basket of goods most frequently purchased by all consumers. Each formula divides the current price of each item by a base year and multiplies the result by 100 to get a percentage of inflation; Calculating the CPI for multiple products may involve weighting each item in the product basket.

The monthly CPI figure reported through news outlets generally represents a basket of goods most frequently purchased by all consumers.

Economists often select a base year to start CPI calculations. This year is not always important, although it must remain the same in all the following years for the formula to make sense. For example, economists might agree that 1984 is a good starting point for calculating the CPI. The base year price for each good in the CPI formula will therefore use the price of each good starting this year. Adjustments or changes may be necessary to take measurements of inflation over a longer period of time.

Calculating the CPI for a single item is quite simple. Economists simply divide the current year 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 claim has increased the price of that item. For example, a 2.1% increase in the price of a gallon of milk is a common response to a single CPI calculation. The biggest problem, however, is that the calculation does not necessarily indicate why the price has increased.

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The fictitious commodity basket in the CPI calculation is a little more complicated. 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 sustain a standard of living. Pondering each item can be difficult; for example, economists might weigh housing at 40 percent, food at 18 percent, and health care at nine 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 basket weight factor. The sum of the final numbers presents a total inflation calculation that should represent the value of inflation in the current market.

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