What is the Consumer Price Index (CPI)?

The Consumer Price Index, or CPI for short, is a way to measure how much prices are going up in a country. It looks at the prices of things that most people buy often, like food, gas, clothes, and housing. Governments use the CPI to see if prices are rising too fast. This is called inflation.

How does the CPI work?

To figure out the CPI, people who work for the government go to stores and write down the prices of many items. They do this every month in different cities across the country. Then, they take all those prices and use math to turn them into one big number – the CPI.

The items they look at are picked carefully to stand for the things most people spend money on. For example, the CPI includes the price of bread because lots of people buy bread. But it might not include the cost of caviar since that’s something fewer people purchase.

Each type of item also gets a unique number based on how much of the money people usually spend on that thing. This is called a “weight.” Things people spend more on, like rent, have a more significant weight in the CPI than things they spend less on, like candy.

Why is the CPI important?

The CPI is a big deal because it tells us if life is getting more expensive. If the CPI goes up, you can’t buy as much with your money as you used to. This especially hurts people who don’t make a lot of money.

Governments and businesses also use the CPI in many ways. Some examples:

• Social Security checks go up when the CPI goes up, so older people can still afford things
• Some workers’ pay goes up with the CPI so their paychecks can keep up with prices
• Businesses use the CPI to decide how much to charge for their products
• The CPI helps the government make important choices about the economy

Detailed Look at CPI

Types of Goods and Services in CPI

The CPI covers all the main things people spend their money on. Here are the big categories:

• Food and drinks (but not alcohol)
• Housing (like rent and furniture, but not the cost of buying a home)
• Clothes
• Transportation (like cars, gasoline, and bus fare)
• Medical care (like doctor visits and medicine)
• Recreation (like TVs, pets, and sports equipment)
• Education and communication (like college, postage, and phone bills)
• Other goods and services (like tobacco, haircuts, and funeral expenses)

Each of these has a lot of specific items in it. There are about 80,000 items in total!

Collecting Prices

The government hires people to be “price checkers.” Every month, these price checkers visit or call thousands of stores, businesses, and offices that sell things to people, like grocery stores, gas stations, and doctors’ offices. This happens in 75 cities across the country.

The price checkers write down the prices they see for each item on the list. Sometimes they have to be a little clever, like if they’re checking the price of a 4-pack of toilet paper but the store only sells 6-packs. Then they use math to figure out what a 4-pack would cost.

They also might need to check the price of the exact same items each time, like a certain brand and style of shirt. This helps make sure the prices are consistent over time.

Calculating CPI

Once the price checkers have gathered all the prices, the numbers go to the people who calculate the CPI. They start by figuring out the average price for each item in each city. So they might find that the average price for a loaf of bread in Chicago is $2.50.

Next, they compare the average price of each item to what it was the last time they checked. If bread was $2.00 last time and it’s $2.50 now, they know the price went up by 50 cents, or 25%.

But remember, not all items count the same in the CPI. The “weight” of each item matters. Let’s say people spend much more money on bread than on apples. The price of bread going up 25% will have a bigger effect on the CPI than if the price of apples went up 25%.

Using a lot of math, the CPI team combines all these price changes and weights to get the overall CPI number. If the CPI is 100, it means overall prices are the same as the last time they checked. Over 100 means prices went up, and under 100 means they went down.

Usually the change in CPI from one month to the next is pretty small, like less than 1%. But even small changes can add up over time to make a big difference in what people can afford.

Uses and Impacts of CPI

Cost of Living Adjustments (COLA)

Many government programs use the CPI to decide how much to raise people’s benefits each year. This is called a Cost of Living Adjustment or COLA. The idea is to make sure these benefits can still buy the same amount of stuff even if prices go up.

For example, Social Security checks for retirees go up each year based on the CPI. If the CPI shows that prices rose 2% over the year, Social Security checks will go up by 2%. This helps seniors on fixed incomes handle inflation.

Contracts and Bargaining

Some workers have contracts that say their pay will go up each year based on the CPI. Their unions bargain for this to protect their members from losing purchasing power due to inflation. If prices go up 3%, they’ll get a 3% raise so they can still afford the same things.

Many business contracts also use the CPI. A landlord might say rent will go up each year by the same percent as the CPI. Or a business might have a contract to provide a service to the city, with the price going up with the CPI each year.

Economic Policy Decisions

The government keeps a close eye on the CPI. If it’s rising too fast, it means inflation is getting out of hand. This can hurt the economy. People may stop spending money because they can’t afford as much. Businesses might struggle as their costs rise faster than their income.

To fight high inflation, the government has a few tools. The Federal Reserve (or “Fed”) can raise interest rates. This makes it more expensive to borrow money, which slows down spending and can cool off inflation.

The government can also cut taxes or spend money on things like roads and schools. This can help boost the economy if inflation has slowed it down too much.

In general, the Fed tries to keep inflation around 2% per year. This is considered a good balance, not too high and not too low. The CPI is their main way of measuring if they’re hitting that target.