Consumer price index is referred to as that index that is used in calculating the retail inflation in the economy by tracking the changes in prices of most commonly used goods and services.
In other words, the consumer price index calculates the changes in price of a common basket of goods and services. It is also called a market basket and is used for calculating the price variations in fixed items.
The market basket that is used by CPI in calculating price changes represents the most common goods and services that are consumed within the economy and is therefore the weighted average for those goods and services.
The items that are considered as a basket are goods related to food, clothing, transportation, housing, electronics, apparels, education, medicine, etc.
CPI can be used to calculate the cost of living of the people of a country and also the changes in the purchasing power of the currency of a nation.
CPI detects the price changes of the items falling under the common basket and by averaging those prices.
CPI is found to be a good measure for determining the rise in prices (also referred to as inflation) and falling prices (referred to as deflation).
How is CPI calculated?
The Consumer Price Index or CPI assesses the changes in the price of a common basket of goods and services by comparing with the prices that are prevalent during the same period in a previous year.
The formula for calculating CPI is
CPI = (Cost of market basket in a given year / Cost of market basket in base year) x 100
Importance of CPI
CPI is a widely used measure for determining inflation in an economy. Rising inflation results in the diminishing standard of living for the residents of a nation. Over a period of time, it will result in an increase in the cost of living.
A high inflation rate will result in increase in prices of goods and as a result there will be less manufacturing, which will result in loss of jobs.
What is Core CPI?
Core CPI is a variation of the CPI in which the Consumer price index is calculated while excluding the volatile commodities like food and energy. This is done by some economists as they are of the belief that due to the volatile nature of these commodities, the price trend will be negatively impacted.
Uses of the Consumer Price Index
- It serves as an indicator of inflation in an economy.
- Can be used to change the components of national income
Limitations of Consumer Price Index
- CPI cannot calculate the variations in two different areas.
- It is a mechanism that detects conditional cost of living and not includes all aspects that impact the living standards.
This concludes the concept of CPI or Consumer Price Index, which is one of the indicators of economic situation of a nation. To read about more such interesting concepts on Economics for Commerce, stay tuned to BYJU’S.
Frequently Asked Questions on Consumer price index
What is the CPI in India in 2020?
CPI was measured at 148.60 in March 2020.
Which item has the highest weight Consumer Price Index?
As per the Consumer price Index food has the highest weightage.