You are watching: A consumer price index attempts to measure changes in
constructing the CPI
Each month, the bureau of job Statistics posting an update CPI. While in practice this is a rather complicated task that needs the factor to consider of thousands of items and also prices, in theory computing the CPI is simple.
The CPI is computed through a four-step process. The addressed basket the goods and services is defined. This needs figuring out whereby the typical consumer spends his or she money. The office of labor Statistics surveys consumer to conference this information. The prices because that every items in the resolved basket space found. Since the exact same basket that goods and services is used throughout a number of time durations to determine changes in the CPI, the price for every items in the solved basket need to be discovered for every point in time. The price of the fixed basket that goods and services need to be calculated for each time period. Like computer GDP, the price of the addressed basket that goods and also services is found by multiplying the quantity of each item time its price. A base year is chosen and the index is computed. The price that the resolved basket that goods and services for each compare year is then split by the price of the fixed basket of items in the base year. The result is multiplied by 100 to give the loved one level of the price of living between the base year and also the comparison years.
For example, let"s compute the CPI for nation B. In this simplified example, consumer in nation B only purchase bananas and also backrubs (lucky fools). The an initial step is to solve the basket of goods. The usual consumer in nation B purchase 5 bananas and 2 backrubs in a given period of time, therefore our fixed basket is 5 bananas and 2 backrubs. The 2nd step is to find the prices of this items for each time period. This data is report in the table, above. The 3rd step is to compute the basket"s cost for every time period. In time duration 1 the solved basket costs (5 X $1) + (2 X $6) = $17. In time period 2 the solved basket expenses (5 X $2) + (2 X $7) = $24. In time period 3 the addressed basket prices (5 X $3) + (2 X $8) = $31. The 4th step is to choose a basic year and also to compute the CPI. Since any type of year deserve to serve together the base year, let"s select time duration 1. The CPI because that time duration 1 is ($17 / $17) X 100 = 100. The CPI for time duration 2 is ($24 / $17) X 100 = 141. The CPI for time period 3 is ($31 / $17) X 100 = 182. Since the price the the goods and also services that consist of the addressed basket enhanced from time duration 1 come time duration 3, the CPI additionally increased. This shows that the price of life increased across this time period.
alters in the CPI end time
As we have just seen, the CPI changes over time together the prices linked with the items in the fixed basket of items change. In the example just explored, the CPI of nation B raised from 100 come 141 to 182 indigenous time duration 1 to time period 3. The percent readjust in the price level indigenous the base year to the comparison year is calculate by individually 100 from the CPI. In this example, the percent change in the price level native the base period (time period 1) come time duration 2 is 141 - 100 = 41%. The percent adjust in the price level indigenous time period 1 to time duration 3 is 182 - 100 = 82%. In this way, changes in the cost of living can be calculated across time.
problems with the CPI
While the CPI is a convenient method to compute the price of living and also the loved one price level throughout time, since it is based on a addressed basket the goods, it does not administer a totally accurate calculation of the cost of living. Three problems with the CPI deserve mention: the substitution bias, the arrival of new items, and also quality changes. Let"s research each of these in detail.Substitution Bias
The an initial problem through the CPI is the substitution bias. Together the price of goods and also services change from one year come the next, they execute not all adjust by the same amount. The variety of specific items that consumer purchase transforms depending upon the family member prices of items in the resolved basket. But because the basket is fixed, the CPI does not reflect consumer"s choice for item that increase in price tiny from one year to the next. For example, if the price that backrubs in nation B jumped come $20 in time duration 4 while the cost of bananas continued to be fixed at $3, consumer would most likely purchase more bananas and also fewer backrubs. This intuitive phenomenon of consumer substituting purchase of low priced items for greater priced items is no accounted for by the CPI.introduction of brand-new Items
The 2nd problem with the CPI is the advent of brand-new items. As time goes on, new items get in into the basket the goods and services purchased by the usual consumer. Because that example, if in time duration 4 consumers in country B started to acquisition books, this would need to be had in an accurate estimate of the cost of living. But because the CPI uses only a addressed basket that goods, the advent of a new product can not be reflected. Instead, the brand-new items, books, space left out of the calculation in bespeak to save time period 4 comparable with the earlier time periods.
See more: Nightmare On Elm Street Chronological Order, Nightmare On Elm Street Movies
The third problem with the CPI is that transforms in the high quality of goods and also services are not fine handled. When an object in the fixed basket of products used to compute the CPI rises or decreases in quality, the value and also desirability the the items changes. Because that example, if backrubs in time duration 4 suddenly became much more satisfying than in earlier time periods, yet the price that backrubs did not change, then the cost of life would continue to be the exact same while the typical of living would increase. This readjust would not be reflect in the CPI from one year come the next. If the office of labor Statistics make the efforts to correct this difficulty by adjusting the price of products in the calculations, in fact this remains a significant problem for the CPI.