Constructing the CPI

The BLS conducts an infrequent survey of consumers to determine the average “basket” of goods and services purchased by urban household. Then each month the BLS records the prices of goods and services in the basket, keeping the representative items as similar as possible in consecutive months. The BLS uses the fixed basket quantities and the recorded prices to determine the cost of the basket each month. The CPI for the month equals 100 multiplied by the ratio of the cost in the current month to the cost in the base period.

For example, suppose the initial survey shows that the CPI basket is 2 books and 20 coffees. The initial base period prices and quantities are in the table to the right. In this base period, say 2005, the cost of the CPI basket is $100.

Next suppose that the BLS survey taken one month in 2011 reveals that the price of a book is $35 and the price of a coffee is $3. These 2011 prices and the initial base period quantities are in the table to the right. In this period the cost of the CPI basket is $130.

Using these data, the CPI equals ($130 ¸ $100) ´ 100, or 130. So between the base period and the current period, the CPI has risen by 30 percent.

Measuring the Inflation Rate

The inflation rate is the percentage change in the price level from one year to the next. In a formula,

In June 2010, the CPI was 218.0. In June 2009, the CPI was 215.7. Between 2009 and 2010, the inflation rate was or 1.1%.

The Biased CPI

The CPI has four biases that lead it to overstate the inflation rate. The biases are:

· New Goods Bias: New goods are often more expensive than the goods they replace.

· Quality Change Bias: Sometimes price increases reflect quality improvements (safer cars, improved health care) and should not be counted as part of inflation.

· Commodity Substitution Bias: Consumers substitute away from goods and services with large relative price increases.

· Outlet Substitution Bias: When prices rise, people use discount stores more frequently and convenience stores less frequently.

Date: 2015-12-11; view: 693