Consumer Price Index (Cpi)

Published Jun 25, 2023

Definition of Consumer Price Index (CPI)

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a basket of goods and services. This basket represents the goods and services that typical households consume, including food, housing, transportation, and medical care. The CPI is a widely used economic indicator that helps to understand inflation trends and is used as a tool for adjusting salaries and wages and for calculating the real value of money.

Example

To illustrate the concept of CPI, let’s assume that a government statistical office collects the prices of 10 goods and services that represent the basket mentioned earlier. Table 1 shows the hypothetical prices for each good in two different years. By dividing the sum of the prices in year 2 by the sum of the prices in year 1 and multiplying by 100, we obtain the CPI for year 2 relative to year 1, which is 126.58. That means, on average, prices increased by 26.58 percent from year 1 to year 2.

Table 1. Hypothetical Prices for CPI Calculation

Using the CPI, policymakers can assess the inflation rate for a certain period and compare it to previous years to determine whether monetary or fiscal policies are needed to stimulate or slow down economic growth. The CPI is also a useful tool for investors to make informed decisions about their asset allocation.

Why Consumer Price Index Matters

The CPI measures changes in the cost of living for typical households, which makes it an essential tool for policymakers, businesses, investors, and consumers alike. The CPI reflects the overall inflation rate in society, which, in turn, affects economic decision-making at all levels. By monitoring the CPI and understanding its implications, stakeholders can make informed decisions about investments, borrowing, and lending, as well as government policy. Being aware of changes in the CPI also allows consumers to adjust their spending habits to maintain their standard of living.