When it comes to Consumer Price Index, a “Basket of Goods” is a collection of hundreds of commonly purchased goods that represent the average American’s spending habits. Here is more information on what it contains and how it relates to the Consumer Price Index (CPI).
What is the Purpose of the Basket of Goods?
Economics is often called the “Dismal Science” because analyzing all of the numbers involved can become mind-numbing. In order to help the regular American understand economic concepts, like inflation, indices are created. Think of the Dow Jones Index or Credit Rating – each represents an idea transformed into a simple number. The Dow Jones represents American productivity and your Credit Rating represents creditworthiness.
While qualitative concepts such as “good” or “better” can be helpful to most of us, statisticians prefer quantitative comparisons. The Bureau of Labor and Statistics (BLS) defines the Consumer Price Index as the following: “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”
Establishing a baseline for the price of a basket of goods allows economists to calculate inflation over time. The United States used the baseline of prices in the years 1982 to 1984 as a reference base equal to 100. Thus, a CPI of 101 would mean a 1% increase in inflation.
What is in the Basket of Goods?
The United States governments uses the Census, “Consumer Expenditure Surveys” tallied from families around the country and retail establishment interviews to compile prices for its basket of goods. Just like Nielsen ratings, the “Consumer Expenditure Surveys” families kept diaries of spending habits over a two-week period.
The BLS actually has at least two index groups for the CPI: A) All Urban Consumers and B) Clerical Workers. The BLS estimates that 87% of Americans are classified under the “All Urban Consumers” group. There are more than 200 sub-categories for this basket of goods including these eight (8) major groups:
- Food and Beverages
CPI is an Economic Indicator
The Federal Reserve (Fed) knows that inflation rates gauge the American economy’s responsiveness to its monetary policies. If you look closely at your United States Dollar, it says Federal Reserve Note on the top. The Fed issues your money.
The CPI is like a report card for the Fed. One of the stated missions of the Fed is to establish a low inflation rate, ideally about 1 to 2%. By using the CPI, the Federal Reserve can adjust its monetary policy to achieve these goals.
High inflation can reduce the amount of “disposable income” that American families have. With fewer dollars in their pockets, citizens might postpone eating out at restaurants, going to sporting events or purchasing brand new appliances.
Senior citizens and government workers may also have an automatic cost-of-living-adjustment (COLA). The CPI can be used to calculate this COLA to ensure that income is inflation-adjusted.
Limitations of the Basket of Goods
In order to compare apples to apples, the items in the basket of goods must remain the same. Of course, American consumers change their product purchases over time (i.e. smart phones). Thus, the basket is only relevant for a limited period of time.
The basket targets the average urban consumer. The poor, wealthy and rural dweller may purchase different items than the average urban dweller.
While the CPI is used for COLA, the CPI does not gauge intangibles, such as quality of life. Some economists prefer the following indices instead: the Producer Price Index (PPI), Employment Cost Index (ECI) and Gross Domestic Product Deflator (GDP Deflator).