Consumer Price Index

Consumer price index is the the key measures of gauging the price level. The most commonly used measure of the level of prices is the consumer price index (CPI). CFI has fundamental impact on the decisions made by policymakers and government.

CPI Overview

Consumer price index calculate a basket of consumer goods. It begins by collecting the prices of thousands of goods and services. Just as GDP turns the quantities of many goods and services into a single number measuring the value of production, the CPI turns the prices of many goods and services into a single index measuring the overall level of prices. How should economists aggregate the many prices in the economy into a single index that reliably measures the price level? They could simply compute an average of all prices.Yet this approach would treat all goods and services equally. Because people buy more chicken than caviar, the price of chicken should have a greater weight in the CPI than the price of caviar. Economists have weighted different items by computing the price of a basket of goods and services purchased by a typical consumer.The CPI is the price of this basket of goods and services relative to the price of the same basket in some base year.

Consumer Price Index VS Producer Price Index

There is a difference between consumer price index and producer price index. The consumer price index is the most closely watched index of prices, but it is not the only such index.Another is the producer price index, which measures the price of a typical basket of goods bought by firms rather than consumers. For more detail analysis of the economy, economists compute also price indices for specific types of goods, such as food,housing, and energy.

Consumer Price Index VS GDP Deflator

There are three key differences between he two CPI and Deflator:

  • The first difference is that the GDP deflator measures the prices of all goods and services produced, whereas the CPI measures the prices of only the goods and services bought by consumers. Thus, an increase in the price of goods bought by firms or the government will show up in the GDP deflator but not in the CPI.
  • The second difference is that the GDP deflator includes only those goods produced domestically. Imported goods are not part of GDP and do not show up in the GDP deflator. Hence, an increase in the price of a Toyota made in Japan and sold in this country affects the CPI, because the Toyota is bought by consumers, but it does not affect the GDP deflator.
  • The third difference results from the way the two measures aggregate the many prices in the economy. The CPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns changing weights. In other words, the CPI is computed using a fixed basket of goods, whereas the GDP deflator allows the basket of goods to change over time as the composition of GDP changes.