Question

Imagine that you are having a conversation with your neighbor. You report that you have just seen the news release that inflation in 2015 was 2.1% in the US. Your neighbor responds, “Ah, government statistics; you can’t trust them. My car payment went up, my college tuition went up, and even my apartment rent went up. I know I am spending more, and the increase has definitely been more than the 2.1% you cite. The government is just playing games with the numbers, just trying to pretend that the prices are rising slower than they actually are to keep us happy.” Can your neighbor be right in thinking that “government is just playing games with the numbers” / his cost of living rose by more than the 2.1% rise in CPI? Please write the correct response to your neighbor.

Answer 1

Inflation is the rise in prices in simple terms. The policymakers at the central bank and government keeps a close watch on this because a higher inflation raises the cost of living something unpopular to the masses and also creates financial problems because it erodes the buying power of the currency. If the inflation is said to be 5% then it means the prices have been higher by 5% as compared to the reference year.

The inflation is measured WPI which is 'Wholesale Price Index' and CPI which is 'Consumer Price Index'. Generally, CPI is more relevant to the general public because it is the index which measures the cost to the consumers.
The CPI is the measure of the prices of basket of goods and inflation is calculated using this fixed basket.

However, over the period of time the good preferred or essential for public changes and if that is not included in the basket then it could give misleading numbers. The internet service was not the part of monthly expenditure but today it is common for any person. Similarly, it is possible that some items actually much more costly than the average inflation. The college tuition fees has been on the rise in the last two decades and it is actually much more than the CPI rate.

The neighbor is quite right is he says that his cost of living has gone up more than the CPI of 2.1%. The CPI is the basket of goods and if his consumption items are not in that basket and if the prices have been higher then he is quite correct.