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Consumer Price Index (CPI)

Consumer Price Index (CPI)

Intermediate
A Consumer Price Index (or CPI) is a type of index: a basket of assets whose price is tracked to gain insights into market segments. Examples of indices include the S&P 500, the NASDAQ Composite, and the DJIA (all of which measure the performance of the major stocks).

There鈥檚 no single CPI 鈥 the term refers to any type of index designed to track the prices of consumer goods, services, and household products. Suppose that we have a basket made up of the following expenses: groceries, hygiene products, travel costs, rent, etc. Basically, we can do this with anything you鈥檇 expect the average consumer to spend on.聽

We鈥檒l note down the total cost of the items in that basket, typically using weighted averages to give more 鈥渨eight鈥 to more important items. Then we鈥檒l note the year/month/period, too. By doing this at set intervals, we can get an idea of how the index is performing over time.


Why is CPI used?

A Consumer Price Index is a powerful benchmark for measuring developments in the economy. Specifically, it鈥檚 used to monitor the impact of inflation or deflation. This is useful for many reasons 鈥 governments can gain insights into their monetary policy decisions and calculate how much should be given to those with subsidized incomes.聽


Calculating CPI

Let鈥檚 say that we鈥檝e observed the following:

Year

Basket value

2014

$30

2015

$31

2016

$32

2017

$32

2018

$33

2019

$34


We could plot these values on a chart to see how the value of the basket changes year-by-year. What we see here is a steady increase. That allows us to estimate that the costs of various goods and services in the basket are rising due to inflation.

First, we want to calculate CPI per year. 聽We take a base year (the one we鈥檒l be using to compare with everything else) 鈥 let鈥檚 use 2014. Then, for every row in the table, we鈥檒l perform the following calculation:


CPI = current year / base year * 100


Here鈥檚 our updated table:

Year

Basket value

CPI

2014

$30

100

2015

$31

103

2016

$32

107

2017

$32

107

2018

$33

110

2019

$34

113


Now, we can calculate inflation or deflation with the following formula:


(CPI in year two - CPI in year one) / CPI in year one * 100


For instance, we could say that inflation has risen by ~2.72% from 2018 to 2019, or by ~7% from 2014 to 2016. In the case of deflation, we鈥檇 expect a negative number.聽

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