The Consumer Price Index (full form – CPI) is the combined estimate of the price levels of various goods and services in an economy. It generally refers to goods and services usually purchased for mass consumption.
Understanding the CPI is crucial for understanding the country’s economy’s overall health along with its prospects and challenges. Let’s delve deep into the topic.
The Consumer Price Index (CPI) can prove to be a handy tool for understanding the consumption behaviour of the masses. The CPI is one of the most recognised methods to evaluate inflation by policymakers, economists, businessmen, and consumers. The CPI measures the general change in the pricing of consumer goods and services over a period of time.
For a nation, the CPI is an essential tool to track the price of everyday consumable goods or services. They cover products related to FMCG (mainly food), clothing, transportation, and other goods and services consumed by the masses daily. The CPI is a numerical estimation created by the prices of particular items into account over a particular time. The CPI is used as the benchmark to adjust wages, salaries, and pensions.
The price index is usually calculated monthly or quarterly, depending on the country and its policies. Member countries of international organisations like the Organisation for Economic Co-operation and Development (OECD) use CPI for estimating inflation.
The price of various products and services calculated as per CPI for inflation is considered against the prices of those goods and services during other months. The goods and services considered for determining the inflation index include common goods and services, called the market basket.
The CPI is used to measure the purchasing power of the masses and how much a consumer would spend to be on par with the change in pricing to maintain their standard of living.
Note that the CPI is a price inflation index for consumer goods and is used to calculate retail inflation and is different from WPI (Wholesale Price Index), which is used to calculate wholesale inflation.
The Reserve Bank of India (RBI) and other financial institutions study the CPI to recognise the price change of different products and keep an eye on the CPI inflation.
The CPI is measured using a base year which acts as the starting point. The price change is measured relative to the base year. To calculate the CPI, we consider the basket’s cumulative price in 1 year and divide it by the price of the market basket of the base year. The result is multiplied by 100 to arrive at the final CPI value.
The CPI is calculated by dividing the Cost of the Market Basket in a given year by the Cost of the Market Basket in Base Year and multiplying it by 100. Here’s the formula:
The market basket is developed using comprehensive expenditure information. The information is gathered via surveys of individuals, households, and businesses. Governments spend considerable resources and time to precisely gather the expenditure information and accurately calculate the CPI.
Here is a list of some of the most important consumer price index uses and benefits:
Although measuring CPI in a country is immensely advantageous, it also comes with a few drawbacks. Some of these include:
Over the years, the CPI has emerged as a popular method to calculate price inflation and is used as a macroeconomic indicator by the Government of India and the Reserve Bank of India (RBI). They use the CPI to check the price inflation and plan their economic policies based on it. The Government and the RBI use the CPI to supervise price stability and as a deflator in national accounts.
Inflation is the change in the average price of products and services at regular intervals. It represents the purchasing power of a unit of a country’s currency concerning the difference in the price of various products and services. An increase in prices of different commodities and services would mean a decrease in the currency’s purchasing power and vice versa.
The Consumer Price Index is a crucial indicator for banks, governments, and financial institutions to understand an economy’s inflation rate and price index changes. The consumer price index uses multiple variables and calculation methodologies to determine the retail inflation rate for a particular month or quarter.
The CPI is designed to estimate the overall changes in the pricing of selected goods and services purchased by the masses mainly for their individual or domestic consumption.
Ans. When the CPI inflation rate for selected goods and services increases, there is a proportionate reduction in the currency’s purchasing power. The masses would now have to spend more capital on maintaining their lifestyle or would do the opposite and reduce their purchases of leisure items and focus on basics.
Ans. No, CPI is not the only actual measurement of inflation. CPI is beneficial in tracking the changes in consumer spending patterns as the price changes and the retrospective change in the purchasing power of the consumers.
Ans. CPI does not measure the price change in rural, regional or remote areas. The CPI also does not consider the stark difference in spending patterns among individuals and households because the spending pattern of households is way different from individuals.
Ans. The CPI covers all goods and services that are purchased for consumption either by households or individuals and includes food and beverages, housing, fuel and light, clothing and footwear, pan, tobacco, and intoxicants. Housing is not included under the CPI retail inflation rate.
Ans. Based on the report in 2001 by the National Statistical Commission led by Dr C. Rangarajan, starting from January 2011, the Consumer Price Index would replace the Wholesale Price Index for consumption-based inflation for rural, urban, and combined.
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