University:
Baltimore City Community College
Course:
ECO 201 | The American Economy I: Macroeconomic Theory
Academic year:

2024
Views:

348

Pages:

2
Author:

Danny A.

The Consumer Price Index A price index measures how the cost of purchasing a certain standard market basket of goods and services varies from the cost of purchasing the same market basket in the base period. It is calculated as the ratio of the current cost of a given market basket to the cost of the same market basket in the base period multiplied by 100: The value of the index is always 100 in the base year because the numerator and denominator of the equation will be the same in the base period. The consumer price index (CPI) is the price index most commonly used to measure the impact of inflation on households. This index is based on a standard market basket of goods and services purchased by a typical urban family. The consumer price index does not include exported goods, investment goods, or items purchased by governments. However, changes in the prices of imported goods purchased by the typical urban family are considered when calculating the CPI. The goods in the CPI market basket are based on a survey conducted once a decade by the Bureau of Labor Statistics. The most recent survey resulted in a revision of the goods in the market basket in 1987 (see Principles in Practice box). The CPI used 1967 as its base year until the beginning of 1988. Since 1988 an average of prices for the years 1982 to 1984 has been used in calculating the base period cost of the market basket. The CPI is actually a weighted average of a number of component price indexes. Price indexes for such items as housing, transportation, food and beverages, and other broad categories for expenditure are computed separately. Then each price index receives a weight that indicates the relative importance of the item in consumer spending. For example, housing is presumed to account for 42.6 cents of each dollar spent by the urban family. The index measuring the price level for an aggregate of housing services is therefore multiplied by 0.426 when calculating the "all items" CPI. Entertainment is currently assumed to absorb 4.4 cents of each dollar spent. The price index for entertainment items will therefore be multiplied by a weight of 0.044 when calculating the "all items" index. Because the weight attached to housing exceeds the weight attached to entertainment items, a given percentage increase in the price of housing will have a much greater impact on the CPI than the same percentage increase in the price of entertainment items. For the current CPI, a 4-percent increase in the aggregate price of housing services will receive nearly 10 times as much weight in calculating the "all items" CPI as a 4-percent increase in the price of an aggregate of entertainment items. Measuring Inflation Annual rates of inflation are measured by the percentage change in a price index, such as the CPI, from one year to the next. For example, the monthly average of the consumer price index in 1989 using the average of prices between 1982 and 1984 as the base was actually 124.0. In 1988 the monthly average of the CPI was 118.3. To calculate the percentage change in the CPI, first take the change in the price index over the year, which in this case is (124.0 118.3). Next divide the change in the price index by its value in the initial year, 1988, and multiply the result by 100 percent to convert to a percentage increase. The rate of inflation between 1988 and 1989 was therefore: