Consumer Price Index Lecture Notes

Consumer Price Index (CPI)

Measures the overall level of prices.
It gauges the overall cost of goods and services bought by a typical consumer.
The Bureau of Labor Statistics (BLS) is the entity responsible for its calculation.

Fix the basket:
- Select goods and services most important to the typical consumer.
Find the prices:
- Collect prices at each point in time.
Compute the basket’s cost:
- Use the same basket of goods & services over time.
- Isolate the effects of price changes.

Expenditures in year 1 are calculated as:
- (Price in year 1) X (Quantity in year 1) and added together for all goods and services.

Choose a base year and compute the CPI
- Base year = benchmark
- The formula to calculate CPI is:
  CPI in current year = \frac{Expenditures\,in\,current\,year}{Expenditures\,in\,base\,year} × 100
- CPI in year 2:
  CPI\,in\,year\,2 = \frac{Expenditures\,in\,year\,2}{Expenditures\,in\,base\,year} × 100
- CPI in year 1:
  CPI\,in\,year\,1 = \frac{Expenditures\,in\,year\,1}{Expenditures\,in\,base\,year} × 100
Compute the inflation rate
- The formula to calculate the inflation rate is:
  Inflation\,rate\,in\,year\,2 = \frac{CPI\,in\,year\,2 - CPI\,in\,year\,1}{CPI\,in\,year\,1} × 100

The figure illustrates how the typical consumer divides spending among various categories of goods and services.
The Bureau of Labor Statistics calls each percentage the “relative importance” of the category.

Substitution bias
- Prices do not change proportionately.
- Consumers substitute toward goods that have become relatively less expensive.
Introduction of new goods
- More variety of goods becomes available.
Unmeasured quality change
- Changes in quality of goods and services.