Consumer Price Index
Consumer Price Index is a measure of the change in prices of market basket of products and services bought by households. CPI is measure by recording the changes in prices of items which are pre-determined to be a part of market basket. Percentage change in CPI is taken as a measure of inflation. It is helpful in showing real changes in values. Sub-indexes and sub sub indexes are also calculated for different categories or sub categories.
Two kinds of data are needed to calculate CPI – Price data and Weighing data. The weighing data is an estimate of share of expenditure of sub categories in comparison to total expenditure in the predetermined market basket items.
Before learning how to calculate CPI, we need to know the meaning of certain terms.
- Base year – It is the year in comparison to which CPI is calculated.
How do you calculate CPI? There are two methods of calculating CPI –
- Calculating the CPI for a single item – Current item price ($) = (base year price) * [(Current CPI) / (Base year CPI)].
Alternatively, CPI can be calculated as CPI = (updated cost/Base period cost)*100.
- Calculating the CPI for multiple items –
CPI is used as a measure of inflation. People are often confused between CPI, PPI and GDP deflator. CPI is different from PPI in that it does not include any raw material or intermediate goods useful to factories and firms. CPI also differs from GDP deflator due to the fact that the latter measures change in price of everything that is produced within the borders of the country. CPI only measures change in goods and services which are relevant to the consumers.
CPI is used to useful for Forex traders. CPI is used by the central banks in deciding the bank rates. Bank rate is of keen interest to Forex traders as well as currency speculators. Hence, the CPI acts as an early indicator to gauge the future policy measures of the central bank. CPI also impacts the politics of a country as high inflation annoys the populace who wants a commensurate increase in wages or the prices of consumer goods and services to remain fairly stable. Major deviations from the expected CPI has many times cause a change of regime in many countries. It is possible to anticipate whether a currency will gain or lose value in comparison to a currency of a country which has a similar economic structure. The currency of a nation with higher inflation rate will appreciate over time compared to the currency of a nation which has a lower inflation rate.
Components of Consumer Price Index in India – There are five broad components of the CPI for India:
- Food, Beverages and Tobacco
- Fuel and Light
- Clothing, Bedding and Footwear
Consumer Price Index of India –
|Index Number||Base Year||All India General Index|
|Consumer Price Index Numbers for Industrial Workers – CPI(IW)||2001=100||269|
|Consumer Price Index Numbers for Agricultural Laborers||1986-87= 100||853|
|Consumer Price Index Numbers for Rural Laborers||1986-87=100||857|
CPI is one of the main determinants of central bank’s interest rate policy. If inflation is high, central banks generally increase the interest rates thereby making borrowing more expensive and hence controlling the money supply and the liquidity in the economy.