CPI

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Description: One of the major factors to consider while studying Macro-Economics is the measure of consumer price levels. There are different measures to calculate, however the most used and applicable method is the Consumer Price Index (CPI). CPI measures percentage change in the price levels of goods that are purchased by a typical household each month.

CPIs are of many types which are calculated in different ways in different regions, types of customers, types of products/services etc. However, the most common type of CPI is known as CPI-U i.e., consumer price index for all urban consumers. The increase in the level of CPI depicts the increase in inflation level. The increase in inflation is merely the measure of increase in CPI level in a year, which is often measured on annual basis.

Uses of CPI There are many important uses of CPI, which include the following:   

CPI is an economic indicator, it is the most used measure of consumer prices level.

CPI gives reference for the agreements of escalation. The contracts and agreements such as labor contracts and loan payments that are subjected to inflation are depended on CPI. CPI also serves as a deflator for economic series. CPI is used as a deflator when the series of economic data has to be adjusted for reporting in constant dollar figures.

CPI Biases There is a limitation attached to CPI as well, which is overstating of the inflation level. The reason for overstating inflation level is because of the biases mentioned below: 

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Substitution Biases: Consumers have a tendency to choose the least priced products as alternatives, when the price level of the products in consumer basket increases significantly. For instance, when price level of oranges in Florida increases due to the freezing weather, customers move to cheaper substitutes such as Texas grape fruits. Here the drawback is the fixed-weight price index on which CPI relies, and thus CPI would not measure the increase in the price level of the consumer basket accurately.

Quality Bias: The usefulness of products and their life quality are increased over time by the advancement in technology. For Instance, over years the life of automobile tires has increased along with the decrease in cost but CPI fails to depict improvements of this sort.

New Product Bias: The new products do not become a part of the index unless they become ordinary in use by customers and thus, the price decrease with the better products is not reported by CPI. Outlet Bias: CPI also fails to report the consumer shift to new outlets such as online retailers and wholesale clubs.

Most of the economists believe that these biases cause CPI to increase by 1% per year.

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To learn more on CPI and its calculation, follow this link: http://www.researchomatic.com/macroeconomic-148733.html

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