Economics Part B

The Consumer Price Index

The Consumer Price Index is designed to monitor the basket price, through a technique that will soon be explained..

The date on which the price monitoring begins is called the base date. The basket price is initially calculated on this date.

What is the Consumer Price Index?

The Consumer Price Index monitors the basket price starting on the base date.

The first figure for the index is denoted as 100 points, or 100%, and the following figures are larger or smaller depending upon any increase or decrease in the basket price as compared with the initial figure.

The index figures are usually quoted in points, and not as percentages, but obviously the same results will be obtained regardless of whether points or percentages are used, as shown in the following example (Table 8.1).

Table 8.1


Development of the Consumer Price Index (example only)

Month

Basket Prices (not real)

Index in Points

Comments

j

k

l

m

1/2008

$250

100

2/2008

$260

104

4% rise in prices, compared with the first observation

3/2008

$265

106

6% rise in prices, compared with the first observation

Another example

Assume that the basket price on the base date is $2,500.

This price equates with 100 points, while on the base date the index also equals 100 points.

After the base date, the basket price rose by 5% to $2,625.

The rise in the basket price reflects a parallel rise in the index. The index also rises 5%, and the revised index will therefore equal 105 points.

 

The technique of measuring basket prices

Once each month, the basket price is determined for the remainder of that month. The prices of items included in the basket are checked several times during the month and the determining price represents the average price for the individual items. As a result, the basket price for any month equals the average price of the basket during that month.
Monthly publication of the index

The basket price calculated each month is translated into index points, which are then published on the 15th of the following month (for example, the basket price for January is published on February 15th).

The published index includes two figures:

  1. The index in points for that month.
  2. The percentage rise of the index as compared with the preceding month.

The accepted unit for the index – percentages

The index converts the monetary changes of the basket price from one date to another into points. The points are customarily converted into percentages.

The inflation rate is presented as percentages on an annual basis

Examples

  1. If the Consumer Price Index rises 0.5%, then the annualized inflation rate is 6% (0.5% X 12 months).
  2. If the Consumer Price Index rises 3% during a four-month period, then the annualized inflation rate is 9% ((3%/4 months) X 12 months).

A note concerning precision

The actual annualized inflation illustrated in Example 1 is slightly higher than 6% (6.2%), and the annualized inflation rate shown in Example 2 is 9.3%.

The reason is that the calculation of price increases from one period to another (either one month or four months) must be performed according to the formula for compound interest, i.e. price increases in any given period also correspond to all price rises during previous periods.

 

Measuring inflation and its level

The rate of change in the index constitutes the inflation rate. If (as presented in Section 2 of the previous example) the index had risen 3% during four months, then the inflation rate would be 9% per year.

The Consumer Price Index564The Consumer Price Index