Page 171 - Encyclopedia of Business and Finance

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Consumer Price Index

The goods and services are divided into more than 800 cat- past. The point of the base year is to serve as a factor in
egories and then arranged into eight major groups: food calculating price changes.
and beverages, travel, apparel, transportation, medical care,
recreation, education, and communication.
CHALLENGES IN SECURING THE
In an overly simplified example, the CPI would work DATA
like this: Consumers vary their retail buying decisions based on
Suppose you purchase one each of five different items and many criteria—such as convenience, color, size, and taste.
services at the prices indicated below. Since the quantity Nevertheless, they do change their minds. “Change” is one
of items and service are all the same, it will not be neces- of the most important factors with which the CPI must
sary to weight the items. deal in its quest to ensure that the price data reported are
accurate. As brand-new major items begin appearing in
retail stores, the CPI may “suddenly” need to investigate
Quantity Cost x nationwide for items that a short time ago were not even
Item Cost purchased Quantity on store shelves. Even beyond this, the timing for the
newly arrived products and/or services may not be pre-
A $21.00 1 $21.00
dictable. The CPI obviously lives in a world of challenges.
B $36.00 1 $36.00
C $18.00 1 $18.00
D $43.00 1 $43.00 INFLATION
E $36.00 1 $36.00 Prices of goods and services are tracked by the CPI
Total — 5 $154.00 because significant increases in retail prices may affect the
overall results and create a grand total increase in prices.
Average cost is $30.80 (154/5 = $30.80) This, of course, suggests inflation. Retailers take note of
price increases that are affecting the products with which
they deal. They may very likely consider this as justifica-
tion for raising their own prices, which results in inflation.
Now suppose the quantity purchased differs with the var-
The role of the CPI has been to measure change in prices.
ious items. It will be necessary to weight the items.
Before the 1970s the average consumer did not tend
to devote much attention to changes in the price levels.
With the advent of the CPI, however, any strong rises in
Quantity Cost x inflation and reporting of such by the newspapers and
Item Cost purchased Quantity other media literally made headlines. More citizens sought
A $21.00 1 $21.00 to increase their knowledge of inflation.
B $36.00 3 $108.00 Escalation is a technique of using strategies to handle
C $18.00 1 $18.00 inflationary data as positively as possible. Escalation agree-
D $43.00 4 $172.00 ments may use the CPI to adjust payments planned and
E $36.00 10 $360.00 subject to adjustment based upon results of the periodi-
Total — 19 $679.00 cally published the CPI reports.

Average cost is $35.74 (679/5 = $35.74)
EFFECT OF SEASONAL
FLUCTUATION
The CPI has found it necessary to calculate seasonal fluc-
The average cost is then compared to a base-year cost to tuation so as to distinguish bona fide changes in the value
calculate the CPI. of money as contrasted to changes that make their appear-
ances on a repetitious basis.
BASE YEAR
To calculate the CPI, a base year (usually a starting time SAMPLING ERRORS
such as a month and a year) should be selected. The base- The CPI measures price changes based on sampling. This
year value is ordinarily shown as a percentage with the means that even when data are handled accurately, the
percentage symbol omitted, often 100.0. An example “luck of the draw” may cause the sample mean to differ
might be Base Year percentage 100.0 and Current Value from the population mean. Sampling “errors” are not mis-
139.9. The base-year value is usually some time in the takes. They are actually “differences.”

148 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION