What is Consumer Price Index?
The “Consumer Price Index (CPI)” is an economic indicator widely used for measuring the change in the prices of goods and services averaged over a period of time with respect to the money spent by consumers. While the definition of CPI remains same, it is the type of consumer that differs from country to country. While US uses urban consumers as contributing factor, countries like India and other developing countries follows a combination of population mix to arrive at consumer price index.
CPI is derived for individual items, item categories, areas and regions and nation as a whole. The consumer price index finds its most important uses as an indicator of the economy besides its application in the adjustment of price escalations in labour and materials. It is also used as a significant component in altering the currency value.
What is exactly reflected by the CPI?
Chiefly CPI represents the pattern of spending by the population. Population is divided into groups of consumers as those from urban back ground and those comprising of rural groups. Normally the wage earners be it industrial workers, agricultural workers or the clerical staff are included in the sample population. The population sample does not include people from military services and those engaged in institutions like jails and mental asylums. The routine house hold expenditure met out of salary component. One of the important prerequisites is that the sampler should have in service for than 37 weeks in a year. Because it represents cost variations in costs of variety of day to day use items in its basket it is often called as living cost index. But in reality cost of living index differs from consumer price index in many ways as living index is more conceptual term which reflects government policies and other environmental and local factors affecting the consumer’s living standards.
The CPI’s basket of goods and services
The consumer price index is formulated over details of data provided by the selected sample population on what exactly bought by them. To find the trends in actual purchase patterns, often expenditure surveys are conducted and frequently bought out items are listed over a set period. Besides, each item is given a weightage according to its importance. Over 200 categories are determined and included in the consumer price index. Major groups covered in CPI are food, beverages and related items, housing related like rents and other furniture related items, apparel items, transportation items related, medical use related including eye and dental care and hospitalization. It also includes consumer durables such as televisions, sports equipment and other recreation related items, education, communication services and other goods and services such as cigarettes, personal grooming and even funeral expenditure gets weightage in CPI. CPI does not takes in to account the money spent on by savings related instruments. CPI uses scientific and statistical procedures to derive CPI over the categories decided. Time and again the entire CPI basket of goods and services regularly reviewed to include changing patterns of consumer behavior. CPI also bases its index on census data and adjusts population samples accordingly. CPI also takes into account the direct taxes applicable in the purchase of goods services like sales tax, excise duty and service taxes and similar others.
Interpretation and application of CPI
CPI is used to measure the movement in prices over a set reference year. Each item is given index points in reference to the base year and subsequently, the change in the index points of the item is recorded. Finally percentage change is arrived at. The higher the starting index of the given item, the lower will be the percent change. Higher percentage change in the index of an item in relation to the referral year alerts the governments and policy makers for possible course of action. Although not a direct indicator of inflation, CPI provides a picture of inflation from the point of view of consumers. One of important uses perceived of CPI is its application in the calculation of escalations against clauses in the works contracts, although it is not mandatory to use it since it is based on sound scientific and statistical principles and sample sizes.
CPI has its limitations in spite of its strong fundamentals. In the first place it is not a universal indicator reflecting all population groups. In case of United States of America, the consumer price index is designed to reflect inflation and the sample size used consists of 87% of urban consumers. So CPI of USA can not reflect the patterns of influence of rural consumers. While CPI is provided item wise, category wise, area wise and region wise, but drawing comparisons between items and regions does really reflect the actual scenario as the CPI is representation consumers spending pattern rather than actual reasons behind. Again it does not provide the living cost index. Sampling errors and errors from non-sampling sources can offer bias in the CPI.
CPI in India
CPI in India has undergone changes in February 2011 to take into account growing changes in Indian economic scenario leaving the old archaic methods of data collections and processes since several years. The new index now accounts for trends in services with good mix of urban and rural sampling individually and collectively. It is expected to help economists in accurately assessing the price fluctuations in the country’s diverse economy and consumption patterns and preferences. The referral base year is taken 2010 with starting value of 100.