Question

Explain briefly what the consumer price index is trying to measure and how it is constructed. /2

Answer 1

THE CONSUMER PRICE INDEX

•The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer. •The Bureau of Labor Statistics reports the CPI each month. •It is used to monitor changes in the cost of living over time. •When the CPI rises, the typical family has to spend more dollars to maintain the same standard of living. How the Consumer Price Index Is Calculated •Fix the Basket: Determine what prices are most important to the typical consumer. •The Bureau of Labor Statistics (BLS) identifies a market basket of goods and services the typical consumer buys. •The BLS conducts monthly consumer surveys to set the weights for the prices of those goods and services. •Find the Prices: Find the prices of each of the goods and services in the basket for each point in time. •Compute the Basket’s Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times. •Choose a Base Year and Compute the Index: •Designate one year as the base year, making it the benchmark against which other years are compared. •Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100. •Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period. •The inflation rate is calculated as follows:

Inflation Rate in Year 2 ={( CPI in Year 2 - CPI in Year 1)/ CPI in Year 1}*100

•Calculating the Consumer Price Index and the Inflation Rate:

Example•

Base Year is 2002. •Basket of goods in 2002 costs $1,200.

•The same basket in 2004 costs $1,236.

•CPI = ($1,236/$1,200) ´ 100 = 103. •Prices increased 3 percent between 2002 and 2004.