How To Calculate CPI (Consumer Price Index)

Inflation is a common concern among corporate executives, small business owners, hardworking employees, and government leaders. The annual rate of inflation, or the level at which the value of a certain currency is falling and the prices for certain goods and services are rising, has been a common household discussion for decades.

In the United States, the Bureau of Labor Statistics uses the consumer price index, or CPI, to measure changing prices and calculate the country’s current rate of inflation monthly.

Understanding inflation rates and the consumer price index is essential for professionals across all industries and occupations. These careful calculations dictate the value of money and directly affect people’s monthly earning and spending rates.

This simple guide to understanding the consumer price index will give you an inside look at CPI calculations and help refine your understanding of inflation to make sound financial decisions both at work and at home.

What Is The Consumer Price Index?

Consumer Price Index, often abbreviated as CPI, refers to the official measurement of the average change in prices over some time for certain goods and services, also known as inflation. The consumer price index exists to measure the purchasing power of the American dollar, or any other unit of currency for that matter.

When discussing the consumer price index, experts refer to it as representing a basket of goods, services, or products. This title references the goods and services bought by urban consumers and the prices they paid for such items.

The market basket is the basis for calculating the consumer price index. It encompasses a representative selection of products based on expenditure information provided by families, individuals, and businesses and provides a price level to determine changes due to inflation.

Calculating The Consumer Price Index

Now that you understand the consumer price index, you may be asking yourself how exactly it’s calculated.

The consumer price index has been calculated by the United States Bureau of Labor Statistics since 1913. The BLS is tasked with qualifying the aggregate price level in the American economy by determining the most accurate consumer price index each month.

The first step in computing the consumer price index involves determining the market basket. To do this, Bureau of Labor experts examine the buying and spending habits of urban residents and evaluate the spending habits of about 24,000 consumers from across the country and survey about 14,500 families each year.

Following close analyses, the market basket is then created to reflect real consumer expenditures in eight major groups: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services.

Using the market basket, BLS CPI data collectors generate samples for each group by assigning probabilities of a product’s likelihood of being bought, choosing one type, brand, and size of a particular product based on the theory of random sampling.

CPI samples are then repriced monthly or bimonthly for four years, at which point the item is replaced through sample rotation. To accurately calculate the country’s consumer price index, data collectors visit or call thousands of stores and establishments to verify the prices of roughly 80,000 items each month.

Finally, using the base CPI index level of 100 — which was set by the U.S. Bureau of Labor Statistics over the 36 months covering the years 1982, 1983, and 1984 — labor statisticians divide the cost of the market basket in a given year of the month to the cost of the market basket during the base year.

This figure is then multiplied by 100 percent to determine the current consumer price index and analyze inflation rates.

According to the BLS, the CPI is calculated using the following formula: CPI= (cost of the market basket in a given year/cost of the market basket in the base year) x 100%.

The Bureau of Labor Statistics then breaks down these monthly consumer price index calculations based on major metro areas and Census regions.

Specific consumer price indexes are released monthly for the northeast, the midwest, the south, and the west and three major metro areas: Chicago-Gary-Kenosha, Los Angeles-Riverside-Orange County, and New York-Northern NJ-Long Island.

Numerous CPI reports are also published every other month or semi-annually for other metro areas with large populations.

Using the above formula and calculation method, the Bureau of Labor determines the consumer price index for all urban consumers and urban wage earners and clerical workers.

According to BLS data, the consumer price index for urban consumers represents about 93 percent of the total U.S. population, including professionals, self-employed individuals, unemployed people, and retirees in urban or metropolitan areas.

To differentiate between the two groups, the consumer price index for urban wage earners and clerical workers is commonly referred to as CPI-W. In contrast, the consumer price index for urban consumers, the large majority of Americans, is typically called CPI-U.

It’s important to note that the consumer price index does not consider people’s spending patterns in rural, nonmetropolitan areas, people living in farm households, individuals in the armed forces, or those in institutions, including prisons and mental hospitals.

Additionally, while the consumer price index calculation includes sales and excise taxes, it does not consider income or Social Security taxes. Furthermore, it also excludes things like investments, life insurance, and real estate.

How Is the Consumer Price Index Used?

When you break it down, the consumer price index affects nearly all Americans.

Since the consumer price index calculates the most accurate inflation rate across the United States by analyzing the percentage change of prices for various goods and services, CPI is most often used to measure the value of money, economic growth, and effectiveness of government’s economic policies.

This helps the government, citizens, and businesses make smart decisions concerning the economy.

For everyday Americans, the consumer price index is especially important as it automatically provides cost-of-living wage adjustments to millions of domestic workers.

As such, the consumer price index affects the income of almost all American workers, as statutory action mandates that the labor market must account for average inflation adjusting employee wages based on the cost of living.

Additionally, the consumer price index is often used to determine people’s eligibility for various government assistance programs, including Social Security. According to labor statistics, the cost-of-living adjustment for military and Federal Civil Services retirees and millions of Americans on Social Security is affected by the consumer price index.

The CPI is also heavily used and relied on at all levels of government. According to the BLS, the president, congress, and the Federal Reserve Board often look to consumer price index trends when instituting various fiscal and monetary policies and federal regulations.

Understanding Limitations of the Consumer Price Index

Although the consumer price index is, by in large, a useful and accurate calculation of the value of money and a good measure of inflation, it does still have some limitations.

Thoroughly understanding the limitations of the consumer price index can help paint a more realistic picture of the calculations computed using the CPI system and the intricate ways these calculations are applied in everyday life and government policies.

Many experts argue that the consumer price index does not apply to the entire U.S. population. It doesn’t analyze people’s spending habits in rural areas, nor does it estimate the buying trends of specific subgroups within the larger American population.

Still, others maintain that the CPI does not measure every aspect affecting today’s living standards or considers other social and environmental factors. For example, the CPI doesn’t include energy costs, which are often a major monthly expense for most individuals and families.

Lastly, the consumer price index is limited by the market basket and product samples, leading to misrepresentation and miscalculations if sampling errors occur. As such, some critics often assert that the consumer price index understates the rate of inflation.

Final Thoughts

Thoroughly understanding the consumer price index (CPI) is essential for Americans across all professional industries living in urban or metro areas spanning all country regions.

Analyzing monthly consumer price index rates released by the Bureau of Labor Statistics can help you make important financial decisions and figure out how inflation affects you both at work and home.

Being aware of annual inflation, rising food prices, and other price adjustments based on inflation indexes, the changing value of money and the percentage of economic growth is more important now than ever, as inflation numbers and the consumer price index affect nearly every American citizen.

By using this guide to deepen your grasp of the CPI, you’ll be well on your way to understanding the complexities of the United State’s annual inflation rate and the consumer price index used to calculate current inflation and analyze the effects of inflation on the country’s economic pursuits and policies.

Author

Elsie Boskamp

Elsie is an experienced writer, reporter, and content creator. As a leader in her field, Elsie is best known for her work as a Reporter for The Southampton Press, but she can also be credited with contributions to Long Island Pulse Magazine and Hamptons Online. She holds a Bachelor of Arts degree in journalism from Stony Brook University and currently resides in Franklin, Tennessee.