Most of us have heard of the Consumer Price Index (CPI), But just what is it and what does it tell us?
The CPI is a monthly index produced by the United States Department of Labor’s Bureau of Labor Statistics that “represents changes in prices of all goods and services purchased for consumption by urban households.” The CPI is based on prices paid in urban markets for a “market basket” of goods and services. Because the CPI represents spending in urban markets, it includes about 87% of the U.S. population.
The market basket of goods that the Bureau of Labor Statistics (BLS) uses to determine the Consumer Price Index includes 200 categories of items arranged into eight major groups: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication and other goods and services. For each category, the BLS has chosen specific items at selected businesses to represent the entire category. Prices are gathered from approximately 23,000 businesses in 87 urban areas in the U.S. throughout the month and used to calculate that month’s index.
There are actually a variety of Consumer Price Indexes that are calculated from the data. The most commonly reported one is for the entire United States. But there are others that cover smaller areas (e.g., the four census regions and 26 specific local areas) and the individual major groups of consumer items that are listed above. The CPI is often used as an indicator of inflation and is used by business and labor leaders, as well as individual consumers, in making economic decision.
The scatter plot shown above demonstrates how the CPI fluctuates month-to-month. In October 2015, prices rose 0.2% across the United States. But for the next few months, the change was lower, and in two months, December 2015 and February 2016, prices dropped. In January 2016, there was no change. Then there was a rather larger increase of 0.4% in April 2016. Overall, in the 12-month period that ended in April 2016, the CPI was 1.1, indicating an overall 1.1% increase in the prices of items in the market basket.
The “Market Basket” Method
The idea of using a representative sample of items in a much larger population of items is not limited to calculating the Consumer Price Index. Retailers use this process to help determine their competitiveness in the marketplace. A grocery store, for example, makes up what it considers an average basket of products and then compares the prices on those items in its own store to the prices on those same items in a competitor’s store (or several competitors’ stores). There is leg work involved in this process, including the initial determination of which products to select and the on-going comparing of the prices, but this method gives the store a good indicator of whether it is in fair competition with (perhaps even beating) its rivals.
Consumers can use the market basket idea on a smaller scale to compare the costs for using different companies to provide the goods and services they want. As an example, a car owner could ask for the cost of car insurance for specific types and amounts of coverage from several different insurance companies (as opposed to just asking for quotes from the companies, which might include different levels of coverage based on the individual companies’ preferences or guidelines). In shopping online, a consumer might get prices on several different items she wants to buy from several different sites or stores to help determine which one to use for purchasing these and other goods.
The idea behind the market basket approach is comparing apples to apples. So in using this approach, the items in the basket have to be exactly the same, including size, quantity and features. Sometimes, particularly when shopping for items, not all sellers have exactly the same items. In such cases, a consumer may have to compromise a bit on the exact comparison, use different items, or eliminate the seller who does not have exactly the right item from consideration.
If you are interested in learning more about Consumer Price Index, you may want to consider pursuing a degree in data science.