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Define the consumer price index (CPI), inflation, deflation, disinflation, the inflation rate, and real variables.

Explain how price indices can be used to calculate the inflation rate and to compare nominal variables over time periods.

Calculate the CPI, the inflation rate, and changes in real variables.

Define the shortcomings of the CPI as a true measure of inflation.

Explain the costs that unexpected inflation (deflation) imposes on individuals and the economy.

Define (using graphs and data as appropriate) turning points and phases of the business cycle.

Explain (using graphs and data as appropriate) turning points and phases of the business cycle.

Define nominal GDP and real GDP.

Calculate real GDP and the GDP deflator.

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An economy’s performance can be measured by different indicators such as gross domestic product (GDP), the inflation rate, and the unemployment rate.

The economy fluctuates between periods of expansion and contraction in the short run, but economic growth can occur in the long run.

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The consumer price index (CPI) measures the change in income a consumer would need in order to maintain the same standard of living over time under a new set of prices as under the original set of prices.

The CPI measures the cost of a fixed basket of goods and services in a given year relative to the base year.

The inflation rate is determined by calculating the percentage change in a price index, such as CPI or the GDP deflator.

Real variables, such as real wages, are the nominal variables deflated by the price level.

The CPI as a measure of inflation has some shortcomings, such as substitution bias, causing it to overstate the true inflation rate.

Unexpected inflation arbitrarily redistributes wealth from one group of individuals to another group, such as lenders to borrowers.

Nominal GDP is a measure of how much is spent on output. Real GDP is a measure of how much is produced.

Nominal GDP measures aggregate output using current prices. Real GDP measures aggregate output using constant prices, thus removing the effect of changes in the overall price level.

One way of measuring real GDP is to weigh final goods and services by their prices in a base year. Because this can lead to overstatement of real GDP growth, statistical agencies actually use different methods.

Nominal GDP can be converted to real GDP by using the GDP deflator.

Business cycles are fluctuations in aggregate output and employment because of changes in aggregate supply and/or aggregate demand.

The phases of a business cycle are recession and expansion.

The turning points of a business cycle are peak and trough.

The difference between actual output and potential output is the output gap.

Potential output is also called full-employment output. It is the level of GDP where unemployment is equal to the natural rate of unemployment. [See EK MEA-1.E.2]

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APMac Unit 2 Lesson 3 - Price Indices, Inflation and Costs of Inflation

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Start studying APMac Unit 2 Lesson 3 - Price Indices, Inflation and Costs of Inflation. Learn vocabulary, terms, and more with flashcards, games, and other study tools.

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fall or left shift in Aggregate Supply is the cause of Cost-Push Inflation. This can occur from an increase in the cost of production or decrease in the volume of production. While Demand-Pull inflation is caused by an increase in the Aggregate Demand curve. An interaction of cost-push inflation and demand-pull inflation results in the Wage Price Spiral.

The wage-price spiral suggests that rising wages increase disposable income, thus raising the demand for goods and causing prices to rise. Rising prices cause demand for higher wages, which leads to higher production costs and further upward pressure on prices.

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Cost-Push Inflation | Intelligent Economist

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fall or left shift in Aggregate Supply is the cause of Cost-Push Inflation. This can occur from an increase in the cost of production or decrease in the volume of production. While Demand-Pull inflation is caused by an increase in the Aggregate Demand curve.

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In an Aggregate Demand and Aggregate Supply diagram, an increase in the aggregate demand curve leads to an increase in the rate of inflation, i.e., when the aggregate demand for goods and services is greater than the aggregate supply. Demand Pull Inflation is defined as an increase in the rate of inflation caused by the Aggregate Demand curve. It is the most common cause of inflation.

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Demand Pull Inflation | Intelligent Economist

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In an Aggregate Demand and Aggregate Supply diagram, an increase in the aggregate demand curve leads to an increase in the rate of inflation, i.e., when the aggregate demand for goods and services is greater than the aggregate supply. Demand Pull Inflation is defined as an increase in the rate of inflation caused by the Aggregate Demand curve.

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Deflation is defined as the decrease in the average price level of goods and services. It means a general decrease in consumer prices and assets, but the increase in the value of money. If the inflation rate is negative, i.e. below 0%, then the economy is experiencing deflation.

Deflation usually occurs during a deep recession, when there is a sustained fall in demand and economic output. Deflation is measured by a decrease in the Consumer Price Index.

Disinflation is when the price levels are rising but at a slower rate, i.e. inflation rate of 8% vs 5%.

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Deflation is defined as the decrease in the average price level of goods and services. Deflation usually occurs during a deep recession, when there is a sustained fall in demand and economic output. Deflation is measured by a decrease in the Consumer Price Index.

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Explore the different areas of Inflation Island, see how people react to inflation and deflation, and how the scenery changes.

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How would you like to pay $417.00 per sheet of toilet paper?

Sound crazy? It's not as crazy as you may think. Here's a story of how this happened in Zimbabwe.

Around 2000, Robert Mugabe, the President of Zimbabwe, was in need of cash to bribe his enemies and reward his allies. He had to be clever in his approach, given that Zimbabwe's economy was doing lousy and his people were starving. Sow what did he do? He tapped the country's printing presses and printed more money.

Clever, right?

Not so fast. The increase in money supply didn't equate to an increase in productivity in the Zimbabwean economy, and there was little new investment to create new goods. So, in effect, you had more money chasing the same goods. In other words, you needed more dollars to buy the same stuff as before. Prices began to rise -- drastically.

As prices rose, the government printed more money to buy the same goods as before. And the cycle continued. In fact, it got so out of hand that by 2006, prices were rising by over 1,000% per year!

Zimbabweans became millionaires, but a million dollars may have only been enough to buy you one chicken during the hyperinflation crisis.

It all came crashing down in 2008 when -- given that the Zimbabwean dollar basically ceased to exist -- Mugabe was forced to legalize transactions in foreign currencies.

Hyperinflation isn't unique to Zimbabwe. It has occurred in other countries such as Yugoslavia, China, and Germany throughout history. In future videos, we'll take a closer look at inflation and what causes it.

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Zimbabwe and Hyperinflation: Who Wants to Be a Trillionaire? | Marginal Revolution University

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How would you like to pay $417.00 per sheet of toilet paper? Sound crazy? It's not as crazy as you may think. Here's a story of how this happened in Zimbabwe. Around 2000, Robert Mugabe, the President of Zimbabwe, was in need of cash to bribe his enemies and reward his allies.

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Inflation is common in a modern economy. Shifts in supply and demand for goods and services cause prices to change accordingly. When the average level of prices rises, that's inflation. It means that you'll need more money to purchase the same stuff.

Inflation in the United States can be measured using the Bureau of Labor Statistics' Consumer Price Index (CPI) - a weighted average of the price increases. We can calculate the inflation rate by the percentage change in the CPI over a given period of time.

How much do prices actually change? Well, using FRED, we can see that, over the past thirty-three years, prices have more than doubled. That may seem like a lot. However, wages have also risen, on average, by more than prices during that time period. Inflation doesn't necessarily mean that we're worse off.

The inflation rate in the United States has averaged at about 2.5% per year since 1980, which is fairly low and indicative of a stable economy. Prices may be increasing, but the changes are small. Wages have time to catch up. You can be confident that the $5 in your pocket isn't going to be worth drastically less in a year.

Let's take a look at a different scenario -- one that's playing in Venezuela right now. As the country faces an economic crisis, inflation is skyrocketing. Rates reached 180% in 2015 and have continued to rise since. 5 bolívar in your pocket could be worth less even by the end of the day.

But Venezuela still doesn't compare to the hyperinflation that Zimbabwe experienced in the 2000s, reaching dizzying rates of billions of a percent per month. ( See MRU's previous video for more!)

While some inflation is perfectly normal, high rates of inflation make it difficult for consumers to use a nation's currency. If the value is changing a lot by the week, day, or even minute, people don't want to hold onto or accept the currency for goods and services -- leading to a full blown currency crisis.

Up next, we'll take a deeper dive into what causes inflation and its consequences.

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Measuring Inflation | Marginal Revolution University

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Inflation is common in a modern economy. Shifts in supply and demand for goods and services cause prices to change accordingly. When the average level of prices rises, that's inflation. It means that you'll need more money to purchase the same stuff.

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The quantity theory of money is an important tool for thinking about issues in macroeconomics.

The equation for the quantity theory of money is: M x V = P x Y

What do the variables represent?

M is fairly straightforward - it's the money supply in an economy.

A typical dollar bill can go on a long journey during the course of a single year. It can be spent in exchange for goods and services numerous times. In the quantity theory of money, how many times an average dollar is exchanged is its velocity, or V.

The price level of goods and services in an economy is represented by P.

Finally, Y is all of the finished goods and services sold in an economy - aka real GDP. (If you need a refresher on GDP, head back to the first section of the course). When you multiply P x Y, the result is nominal GDP.

Actually, when you multiply M x V (the money supply times the velocity of money), you also get nominal GDP. M x V is equal to P x Y by definition - it's an identity equation.

You can think about the two sides of the equation like this: the left (M x V) covers the actions of consumers while the right (P x Y) covers the actions of producers. Since everything that is sold is bought by someone, these two sides will remain equal.

Up next, we'll use the quantity theory of money to discuss the causes of inflation.

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Quantity Theory of Money | Marginal Revolution University

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The quantity theory of money is an important tool for thinking about issues in macroeconomics. The equation for the quantity theory of money is: M x V = P x Y What do the variables represent? M is fairly straightforward - it's the money supply in an economy.

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In the last video, we learned the quantity theory of money and its corresponding identity equation: M x V = P x Y

For a quick refresher:

- M is the money supply.

- V is the velocity of money.

- P is the price level.

- And Y is the real GDP.

In this video, we're rewriting the equation slightly to divide both sides by Y and explore the causes behind inflation. What we discover is that a change in P has three possible causes - changes in M, V, or Y.

You probably know that prices can change a lot, even over a short period of time.

Y, or real GDP, tends to change rather slowly. Even a seemingly small jump or fall in Y, such as 10% in a year, would signal astonishing economic growth or a great depression. Y probably isn't our usual culprit for inflation.

V, or the velocity of money, also tends to be rather stable for an economy. The average dollar in the United States has a velocity of about 7. That may fall or rise slightly, but not enough to influence prices.

That leaves us with M. Changes in the money supply are the driving factor behind inflation. Put simply, when more money chases the same amount of goods and services, prices must rise.

Can we put this theory to the test? Let's look at some real-world examples and see if the quantity theory of money holds up.

In Peru in 1990, hyperinflation came into full swing. If we track the growth rate of the money to the growth rate of prices, we can see that they align almost perfectly on a graph with both clocking in around 6,000% that year.

If we plot the growth rates of the money supply along with the growth rates of prices for a many countries over a long stretch of time, we can see the same relationship.

We'll wrap-up the causes of inflation with three principles to keep in mind as we continue exploring this topic:

- Money is neutral in the long run: a doubling of the money supply will eventually mean a doubling of the price level.

- "Inflation is always and everywhere a monetary phenomena." - Milton Friedman

- Central banks have significant control over a nation's money supply and inflation rate.

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Causes of Inflation | Marginal Revolution University

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In the last video, we learned the quantity theory of money and its corresponding identity equation: M x V = P x Y For a quick refresher: - M is the money supply. - V is the velocity of money. - P is the price level. - And Y is the real GDP.

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The i nflation rate can be somewhat volatile and unpredictable. For example, let's take the period between 1964 and 1983 in the U.S. The inflation rate jumped around from 1.3% in 1964 to 5.9% in 1970, and all the way up to 14% in in 1980, before dipping back down to 3% in 1983. These dramatic changes, though still fairly mild in the realm of inflation, caught people off-guard.

Peru's inflation rates in the late 1980s through the early 1990s were on even more of a rollercoaster. Clocking in at 77% in 1986, its inflation rate was already quite high. But by 1990, it had jumped to 7,500%, only to fall to 73% a mere two years later.

High and volatile inflation rates can wreak havoc on the price system where prices act as signals. If the price of oil rises, it signals scarcity of that product and allows consumers to search for alternatives. But with high and volatile inflation, there's noise interfering with this price signal. Is oil really more scarce? Or are prices simply rising? This leads to price confusion - people are unsure of what to do and the price system is less effective at coordinating market activity.

Money illusion is another problem associated with inflation. You've likely experienced this yourself. Think of something that you've noticed has gotten more expensive over the course of your lifetime, such as a ticket to the movies. Is it really that going out the movies has become a pricier activity, or is it the result of inflation? It's difficult for us to make all of the calculations to accurately compare rising costs. This is known as "money illusion" - or when we mistake a change in the nominal price with a change in the real price.

Inflation, especially when it's high and volatile, can result in some costly problems for everyone. Next up, we'll look at how it redistributes wealth and can break down financial intermediation.

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Costs of Inflation: Price Confusion and Money Illusion | Marginal Revolution University

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The i nflation rate can be somewhat volatile and unpredictable. For example, let's take the period between 1964 and 1983 in the U.S. The inflation rate jumped around from 1.3% in 1964 to 5.9% in 1970, and all the way up to 14% in in 1980, before dipping back down to 3% in 1983.

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Sure thing. The government borrows a dollars, which is an equivalent of a burger, then debses the currency, prices rise, say two times, and the government pays back the dollars, which can now buy only half a burger. It is not only that the government likes inflation, it has the means to produce it.
In general, in the credit market, when prices rise due to inflation, it is only right to compensate the lender for the drop in value of the currency.
However, when prices rise due to a fall in real GDP (I mean when the same amount of money in circulation is distributed to fewer goods), then we can't justify a compensation for the lender paid by the borrower. This is because borrowers are investors. They project a profit of say, one dollar which is the equivalent of a burger when they borrow. Then, after prices rise due to a fall in real GDP, their one dollar profit can only buy less than a burger. This kind of pricee change does not favor the borrower, and therefore the borrower should not be held to compensate the lender.

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Why Governments Create Inflation | Marginal Revolution University

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Sure thing. The government borrows a dollars, which is an equivalent of a burger, then debses the currency, prices rise, say two times, and the government pays back the dollars, which can now buy only half a burger. It is not only that the government likes inflation, it has the means to produce it.

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Why the Fed Targets a 2 Percent Inflation Rate | St. Louis Fed

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By Kristie Engemann, Public Affairs Staff
A recent Open Vault post explained that the Federal Reserve has a so-called dual mandate for monetary policy-maximum employment and price stability.

The latter, price stability, is often interpreted to mean low and stable inflation. To meet the price stability objective, Federal Reserve policymakers target an inflation rate of 2 percent.

This post discusses some basics on inflation, such as what inflation is and how it is measured. It also discusses the Fed's inflation target, how it came to be, what it means and why the Fed targets a positive number instead of zero percent inflation.

Some Basics on Inflation

Inflation is a general, sustained upward movement of prices for goods and services in an economy. (Think overall prices-not the price of a single good.)

The inflation rate can be estimated using a price index, which gives a sense of how overall prices in the economy are evolving. A common calculation is the percentage change from a year ago. For instance, if a price index is 2 percent higher than a year ago, that would indicate an inflation rate of 2 percent.

One index that economists and policymakers like to look at is the price index for personal consumption expenditures (PCE). Produced by the Bureau of Economic Analysis, this index accounts for prices that U.S. consumers pay for a wide range of goods and services. It includes various prices associated with cars, food, clothing, housing, health care and so on.

For a crash course on price indexes, check outanother recent blog post.

Monetary Policy and Inflation

The Federal Open Market Committee, or FOMC, is the main monetary policymaking body of the Federal Reserve. You may have heard of the FOMC taking policy actions, such as lowering or raising interest rates, in response to economic conditions and in an effort to achieve the Fed's dual mandate.

Monetary policy decisions depend on a wide range of data, but for simplicity, let's just focus on inflation and the target for the federal funds rate.

Too high? If inflation is running persistently too high, the FOMC might raise the target for the federal funds rate in an effort to bring inflation back down.

Too low? In contrast, if inflation is running persistently too low, the FOMC might reduce the target for the federal funds rate in an effort to bring inflation back up.

How the Fed's 2 Percent Inflation Target Came to Be

As mentioned earlier, the FOMC interprets an inflation rate of 2 percent as consistent with price stability. As such, the FOMC adopted an explicit inflation target of 2 percent in January 2012.

In the 2016 version of the statement on longer-run goals (PDF), the FOMC clarified that its inflation target is symmetric (in other words, it isn't a floor or a ceiling). The FOMC added: "The Committee would be concerned if inflation were running persistently above or below this objective."

Although the FOMC didn't explicitly name an inflation target until 2012, St. Louis Fed President James Bullard has argued that the U.S. had "an implicit inflation target of 2 percent after 1995." (See Bullard's presentation from Sept. 12, 2018. In that presentation, he also noted that 2 percent became an international standard in the inflation targeting era that began in the 1990s.)

More Details about the Inflation Target

The Fed's target is based on the annual change in the overall, or "headline," PCE price index. As Bullard wrote in a 2012 Regional Economist article, "The FOMC will target the headline inflation rate as opposed to any other measure (e.g., core inflation, which excludes food and energy prices) because it makes sense to focus on the prices that U.S. households actually have to pay."

Furthermore, the inflation target is meant to be reached over a longer period of time; inflation doesn't have to be 2 percent all the time. In that same article, Bullard explained the period over which the FOMC would aim to hit the target.

"To clarify, this does not mean inflation must be 2 percent in the short term; rather, monetary policy should be set so that inflation moves toward the target over time and, in the absence of unpredictable changes in either supply or demand, would reach 2 percent in the medium term," he wrote.

The figure below shows headline PCE inflation (the measure that the Fed targets) over the past couple decades. It also includes two measures that people sometimes look at to get a sense of underlying inflation trends:

1. Core PCE inflation: This measure excludes food and energy prices.

2. Trimmed mean PCE inflation: This measure, created by the Federal Reserve Bank of Dallas (PDF), excludes a certain portion of the items at the extremes-that is, the items with prices that increased the most or decreased the most in that particular month.

Why the FOMC Targets a Positive Number for Inflation

You might be wondering why the FOMC would target a positive rate of inflation. Why not zero? Or a negative number?

David Wheelock, a St. Louis Fed group vice president and deputy director of research, addressed these questions in a 2017 podcast. He acknowledged that there isn't a general agreement among economists, but he laid out three arguments that people make for having a positive inflation target.

1. Measurement Bias

"[O]ne reason that central banks like the Fed have tended to settle on a numerical target that's above zero is that measuring inflation precisely is very difficult," Wheelock said. He explained that the price indexes that are used to estimate inflation don't necessarily include all goods and services in an economy.

Furthermore, these indexes have a slight upward bias. "So, when the observed rate of inflation is, say, 1 or 2 percent ... the true measure is actually probably lower than that, closer to zero," he explained.

2. Room to Cut Interest Rates

Another reason that some people give for having a positive inflation target is that interest rates and inflation tend to be proportional, Wheelock noted. That means that a higher inflation rate tends to be associated with higher interest rates.

"A higher level of interest rates gives the Fed a little more room to cut in the event of a recession," he said. "So it's a bit of a cushion that allows monetary policy to operate a little more through its traditional interest rate channel."

3. Avoiding Deflation

A third reason that Wheelock discussed for targeting a positive number relates to providing insurance against deflation. Deflation is a general, sustained downward movement of prices for goods and services.

"[S]ome people think that the effect of deflation of a given size would be more harmful for the economy than a positive rate of inflation of the same number," Wheelock said.

"So, in other words, the costs of a negative 2 percent inflation rate, or a 2 percent deflation rate, would be higher than the costs of a 2 percent positive inflation rate. So, you want to err on the side of having a positive number," he explained.

Ultimately, Why Is an Inflation Target Important?

The FOMC's statement on longer-run goals and monetary policy strategy (PDF) explains the importance of announcing an inflation target: Doing so "helps keep longer-term inflation expectations firmly anchored."

Why do inflation expectations matter? They are important for actual inflation, as Bullard explained in a 2016 Regional Economist article. "Modern economic theory says that inflation expectations are an important determinant of actual inflation," he wrote.

He further explained: "Firms and households take into account the expected rate of inflation when making economic decisions, such as wage contract negotiations or firms' pricing decisions. All of these decisions, in turn, feed into the actual rate of increase in prices."

Therefore, stating an inflation goal-and maintaining credibility with respect to that goal-helps the FOMC manage the public's expectations when it comes to inflation. In turn, this helps in achieving price stability as per the Fed's mandate.
Additional Resources

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Why the Fed Targets a 2 Percent Inflation Rate | St. Louis Fed

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Getty/JLGutierrez By Kristie Engemann, Public Affairs Staff A recent Open Vault post explained that the Federal Reserve has a so-called dual mandate for monetary policy-maximum employment and price stability. The latter, price stability, is often interpreted to mean low and stable inflation. To meet the price stability objective, Federal Reserve policymakers target an inflation rate of 2 percent.

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2000 dollars today | Inflation Calculator

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The 2.07% inflation rate means $100 in 2000 is equivalent to $144.59 in 2018. This inflation calculator uses the official US consumer price index.

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1. What is inflation?

2. How do we create an index for  inflation?

3. What are weaknesses inherent in how we measure inflation?

4. What are the similarities and differences between CPI and a GDP deflator?

5. How can we use CPI or the GDP deflator to convert nominal GDP into real GDP?

6. What is the difference between real and nominal GDP?

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What Is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.

The CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. It may be compared with the producer price index (PPI), which instead of considering prices paid by consumers looks at what businesses pay for inputs.

Understanding the Consumer Price Index (CPI)

Inflation is the decline of a given currency's purchasing power over time; or, alternatively, a general rise in prices. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.

The CPI is what is used to measure these average changes in prices over time that consumers pay for goods and services. Essentially, the index attempts to quantify the aggregate price level in an economy and thus measure the purchasing power of a country's unit of currency. The weighted average of the prices of goods and services that approximates an individual's consumption patterns is used to calculate CPI. A trimmed mean may be used as part of this calculation.

The U.S. Bureau of Labor Statistics (BLS) reports the CPI on a monthly basis and has calculated it as far back as 1913. It is based upon the index average for the period from 1982 through 1984 (inclusive), which was set to 100. So a CPI reading of 100 means that inflation is back to the level that it was in 1984, while readings of 175 and 225 would indicate a rise in the inflation level of 75% and 125% respectively. The quoted inflation rate is actually the change in the index from the prior period, whether it is monthly, quarterly, or yearly.

Though it does measure the variation in price for retail goods and other items paid by consumers, the Consumer Price Index does not include things like savings and investments and can often exclude spending by foreign visitors.

How Is CPI Used?

CPI is an economic indicator. It is the most widely used measure of inflation and, by proxy, of the effectiveness of the government's economic policy. The CPI gives the government, businesses, and citizens an idea about price changes in the economy and can act as a guide in order to make informed decisions about the economy.

The CPI and the components that make it up can also be used as a deflator for other economic indicators, including retail sales and hourly/weekly earnings. Additionally, it can be used to value a consumer's dollar to find its purchasing power. Generally, the dollar's purchasing power declines when the aggregate price level increases and vice versa.

The index can also be used to adjust people's eligibility levels for certain types of government assistance including Social Security, and it automatically provides the cost-of-living wage adjustments to domestic workers. According to the BLS, the cost-of-living adjustments of more than 50 million people on Social Security as well as military and federal civil services retirees are linked to the CPI.

Who and What Are Covered in the CPI?

The CPI statistics cover professionals, self-employed and unemployed people, people whose incomes are below the federal poverty threshold, and retired people. People not included in the report are non-metro or rural populations, farm families, armed forces, people currently incarcerated, and those in mental hospitals.

The CPI represents the cost of a basket of goods and services across the country on a monthly basis. Those goods and services are broken down into eight major groups:

The BLS includes sales and excise taxes in the CPI-or those that are directly associated with the price of consumer goods and services-but excludes others that aren't linked, such as income and Social Security taxes. It also excludes investments ( stocks, bonds, etc.), life insurance, real estate, and other items unrelated to consumers' day-to-day consumption.

Calculating CPI

The BLS records about 80,000 items each month by calling or visiting retail stores, service establishments (such as cable providers, airlines, and car and truck rental agencies), rental units, and doctor's offices across the country in order to get the best outlook for the CPI.

The formula used to calculate the Consumer Price Index for a single item is as follows:

The base year is determined by the BLS. CPI data for more recent years are based on surveys collected in earlier years.

Types of CPI

Two types of CPIs are reported each period:

1. The CPI-W is the Consumer Price Index for Urban Wage Earners and Clerical Workers. Between 1913 and 1977, the BLS focused on measuring this type of CPI. It was based on households whose incomes were comprised of more than one-half from clerical or wage occupations, and in which at least one of the earners was employed for at least 37 weeks during the previous 12-month cycle. The CPI-W primarily reflects changes in the costs of benefits paid to those on Social Security. This measurement of CPI represents at least 28% of the country's population.

2. The CPI-U is the Consumer Price Index for All Urban Consumers. It accounts for 88% of the U.S. population and is the better representation of the general public. The BLS made improvements to CPI in 1978 and introduced a broader target population. This type of CPI is based on the spending of almost all of the population that resides in urban or metropolitan areas and includes professionals, self-employed workers, those living below the poverty line, those who are unemployed, and retired people. It also includes urban wage earners and clerical workers.

Despite introducing the CPI-U in 1978, the BLS continued to take the traditional measure of the CPI-W. But since 1985, the main difference between the two indexes has been the expenditure weights assigned to item categories and geographic areas.

CPI Regional Data

The Bureau of Labor Statistics also breaks down the CPI by region. Each month, the report is broken out into the four major Census regions:

Three major metro areas are also broken out each month:

1. Chicago-Naperville-Elgin, IL-IN-WI

2. Los Angeles-Long Beach-Anaheim, CA

3. New York-Newark-Jersey City, NY-NJ-PA

Along with the regional information provided each month, the Bureau of Labor Statistics also publishes reports for 20 additional metro areas every other month. These reports cover areas with large populations and represent a particular regional subset.

Critiques of CPI Methodology

For several years, there has been some controversy about whether the CPI overstates or understates inflation, how it is measured, and whether it is an appropriate proxy for inflation. One of the main reasons for this contention is that economists differ on how they believe inflation should be measured.

Over the years, the methodology used to calculate the CPI has undergone numerous revisions. According to the BLS, the changes removed the supposed biases that caused the CPI to overstate the inflation rate in the past. The newer methodology takes into account changes in the quality of goods and substitution. Substitution, the change in purchases by consumers in response to price changes, changes the relative weighting of the goods in the basket.

The overall result tends to be a lower CPI. However, critics view the methodological changes and the switch from a COGI to a COLI as a purposeful manipulation that allows the U.S. government to report a lower CPI. Today, critics of the CPI argue that the understated inflation metric does not capture the true rise in prices felt by consumers.

How Is the Consumer Price Index (CPI) Used?

How Is the CPI Calculated?

What Are Some Criticisms of the CPI?

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The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.