The Consumer Price Index (CPI) is a crucial metric in terms of measuring inflation from year to year. Let's dig into a simple example to learn how!
Consumer Price Index (CPI) explained
Imagine that you’re a high school student preparing for the upcoming year. Every year before classes start, you go to the store and buy a box of pencils and a notebook.
This year, you noticed that these items (your basket of goods) were more expensive than in previous years.
After talking with your economics teacher, you learn that this increase in price is due to inflation, specifically consumer price inflation.
As you look back through your receipts from previous years’ pencil / notebook purchases, you notice that the prices did in fact increase from year to year. This change in price is tracked through the consumer price index (CPI).
The Consumer Price Index (CPI) is an average price index of several hundred consumer goods and services. It details how the prices of these goods are impacted from inflation from year to year.
On a wide-scale, CPI is a calculation performed by the U.S. Bureau of Labor Statistics (BLS) and is calculated on a monthly basis. They utilize the following formula:
To describe this calculation in words, we are looking at the prices of a basket of goods today...
...and dividing them by the price of the same basket of goods in a previous period.
Doing so gives us a ratio that describes the increase in the prices of these goods and services.
Why do we multiply the result of this by 100?
Because the base, or starting point, for CPI is at 100.
The base / starting point for CPI is 100.
If a basket of consumer goods does not change from one year to the next, then its CPI would remain at 100.
How to calculate CPI
Let's consider the following situation:
Question: Calculate the CPI based on the following table.
|Survey Year||Base Year||This Year|