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What exactly is the Consumer Price Index (CPI) and how is it calculated?

cpiCPI stands for Consumer Price Index, and it is a measure of inflation. It is calculated by measuring the change in a specific group of goods and services over time. The CPI is calculated by the US Bureau of Labor Statistics.

What the CPI Measures

The CPI measures the spending habits for two different groups. The CPI-U measures the spending patterns of all urban consumers. The CPI-W measures the spending patterns of urban wage earners and clerical workers. The spending patterns of people living in rural areas, farmers, members of the armed forces and those institutionalized in prisons or hospitals are not measured. The group of all urban consumers represents about 87 percent of the entire population of the United States. The people who comprise the CPI-W are a subset of the CPI-U.

What the CPI Includes

The CPI includes eight major groups of expenditures. They are:

  • apparel, which includes clothing and accessories like jewelry;
  • education and communication, which includes school tuition, telephone and internet services, and computer software and accessories;
  • food and beverages, which consists of grocery items as well as dining out;
  • housing, which includes rent or mortgage payments, utilities and furnishings;
  • medical care, including prescriptions, hospital services, doctor’s services, and dental and vision products and services;
  • recreation, including admission to spectator sporting events, toys, pets, and sports equipment;
  • transportation, comprised of vehicle leases and purchases, gas, insurance, and airplane and train fares; and
  • other goods and services, such as personal services like hairdressing, funeral expenses, and tobacco and smoking products.

Taxes on items purchased and excise taxes are included in CPI, as are user taxes like tolls. Income taxes are not included. Investments and savings vehicles are not included.

How the CPI Data is Published

The CPI data is published nationally and by region every month. The regions are the Northeast, Midwest, South and West. The data is also published by metropolitan area. The Chicago, Los Angeles and New York data are published every month. Data for the other 11 metropolitan areas are published every other month. These areas are Atlanta, Boston, Cleveland, Dallas, Detroit, Houston, Miami, Philadelphia, San Francisco, Seattle and Washington DC.

How the CPI is Used

The CPI is used to measure inflation. It is used by government agencies and entities to measure the effectiveness of fiscal and monetary policy, and to determine when that policy needs to be adjusted. It is used by government, private industry, labor unions and individuals to determine how effective current economic policy is.

The CPI is used to determine purchasing power. When you hear the terms ‘in today’s dollars,’ or ‘adjusted for inflation,’ the values discussed have been adjusted by using the CPI in order to reflect true purchasing power, or the amount a dollar will buy, at different times in history.

The CPI is used to adjust Social Security and other income payments, and to adjust the level of income required for eligibility for government programs. Retirees, whether they collect Social Security or a military or civil service pension, recipients of food stamps, and children who receive free or reduced price school lunches are all affected by changes in the CPI.

The Difference Between CPI and a Cost-of-Living Index

The CPI is often referred to as a cost-of-living index, but there is a difference. The CPI reflects what consumers are actually buying, while a cost of living index reflects the amount of income necessary to maintain a certain standard of living.

When consumers have less income, they tend to substitute less expensive versions of the same item in their budgets. Since the CPI reflects the cost of what they actually buy, this measure may drop when substitutions are made. A cost of living index, on the other hand, would reflect the cost of a certain item over time, which will almost always go up.