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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).

ThereÔÇÖs no single CPI ÔÇô 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 youÔÇÖd expect the average consumer to spend on.┬á

WeÔÇÖll note down the total cost of the items in that basket, typically using weighted averages to give more ÔÇťweightÔÇŁ to more important items. Then weÔÇÖll 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, itÔÇÖs used to monitor the impact of inflation or deflation. This is useful for many reasons ÔÇô governments can gain insights into their monetary policy decisions and calculate how much should be given to those with subsidized incomes.┬á


Calculating CPI

LetÔÇÖs say that weÔÇÖve 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. ┬áWe take a base year (the one weÔÇÖll be using to compare with everything else) ÔÇô letÔÇÖs use 2014. Then, for every row in the table, weÔÇÖll perform the following calculation:


CPI = current year / base year * 100


HereÔÇÖs 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, weÔÇÖd expect a negative number.┬á

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