Consumer Price Index

The Consumer Price Index or CPI is a measure of the prices of consumer goods and services bought at retailprices. This includes food, fuel, clothing and pharmaceuticals. The percentage change in CPI measures inflation. To compile the Consumer Price Index, a predetermined set of goods, forming a typical basket of goods bought by an average urban consumer, is selected. All the items are weighted according to the percentage of income that households spend per category. An average of thechange in the prices of these items is calculated on a monthly basis. Core CPI excludes food and energy prices, which are often volatile, and is an indicator of the headline inflation rate.

Uses of Consumer Price Index

Apart from measuring inflation, the index is useful in indicating the need to adjust:

wages to keep pace with a rise in the cost of living

pensions

regulated prices

tax brackets to avoid increases in the rate of taxes induced by inflation

The Consumer Price Index is also used as a factor to translate long-term financial figures or related indices into inflation-free or adjusted values.

Consumer Price Index: How is it Constructed?

CPI is constructed through two kinds of data:

• Price data: Using the sampling method, this data is collected for goods and services from sales outlets in different locations and for various times.
• Weighting data: This is the data on various types of expenditure, used to represent the surveyed population from which the sample is taken.

A comparison of prices of various items under the constituents of consumer expenditure (such as food, clothing and housing) is done every month with their prices in the price-reference month. A base year is selected and changes are presented as:

• percentage of the previous index levels
• annual growth rate (to give an idea of near-term inflation to investors)

However, volatility of the index from one month to another is one of its weaknesses. Also, some biases related to fixed CPI, such as new product and substitution, can lead to a distortion of results.

The consumer price index, along with national income and population census, is calculated by governmental statistical agencies. The consumer price index report has special importance for investors and triggers a movement in both fixed income and the equitymarket.