Consumer Price Index (CPI) Explained: What It Is and How It's Used (2023)

What Is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) measures the monthly change in prices paid by U.S. consumers. The Bureau of Labor Statistics (BLS) calculates the CPI as a weighted average of prices for a basket of goods and services representative of aggregate U.S. consumer spending.

The CPI is one of the most popular measures of inflation and deflation. The CPI report uses a different survey methodology, price samples, and index weights than the producer price index (PPI), which measures changes in the prices received by U.S. producers of goods and services.

Key Takeaways

• The Consumer Price Index measures the overall change in consumer prices based on a representative basket of goods and services over time.
• The CPI is the most widely used measure of inflation, closely followed by policymakers, financial markets, businesses, and consumers.
• The widely quoted CPI is based on an index covering 93% of the U.S. population, while a related index covering wage earners and clerical workers is used for cost-of-living adjustments to federal benefits.
• The CPI is based on about 94,000 price quotes collected monthly from some 23,000 retail and service establishments as well as 43,000 rental housing units.
• Housing rents are used to estimate the change in shelter costs including owner-occupied housing that account for nearly a third of the CPI.

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Understanding the Consumer Price Index (CPI)

The BLS collects about 94,000 prices monthly from some 23,000 retail and service establishments. Although the two CPI indexes calculated from the data both contain the word urban, the more broad-based and widely cited of the two covers 93% of the U.S. population.

Shelter category prices accounting for nearly a third of the overall CPI are based on a survey of rental prices for 43,000 housing units, which is then used to calculate the rise in rental prices as well as owners' equivalents. The owners' equivalent category models the rent equivalent for owner-occupied housing to properly reflect housing costs' share of consumer spending. User fees and sales or excise taxes are included, while income taxes and the prices of investments such as stocks, bonds, or life insurance policies are not part of the CPI.

The calculation of the CPI indexes from the data factors in substitution effects—consumers' tendency to shift spending away from products and categories has grown relatively more expensive. It also adjusts price data for changes in product quality and features. The weighting of the product and service categories in the CPI indexes corresponds to recent consumer spending patterns derived from a separate survey.

The CPI-U increased 6.5% over the 12-month period ending December 2022. While inflation remains historically high, December's CPI was a welcome change from the 7.1% increase recorded in November 2022.

Types of CPIs

The BLS publishes two indexes each month. The Consumer Price Index for All Urban Consumers (CPI-U) represents 93% of the U.S. population not living in remote rural areas. It doesn't cover spending by people living in farm households, institutions, or on military bases. CPI-U is the basis of the widely reported CPI numbers that matter to financial markets.

The BLS also publishes the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W covers 29% of the U.S. population living in households with income derived predominantly from clerical employment or jobs with an hourly wage. CPI-W is used to adjust Social Security payments as well as other federal benefits and pensions for changes in the cost of living. It also shifts federal income tax brackets to ensure taxpayers aren't subjected to a higher marginal rate as a result of inflation.

CPI Formulas

The more common CPI-U calculation entails two primary formulas. The first is used to determine the current cost of the weighted-average basket of products, while the second is used to analyze the year-over-year change.

Annual CPI Formula

To calculate the annual CPI, the BLS divides the value of a specific basket of goods today compared to one year ago:

\begin{aligned}\text{Annual CPI}=\frac{\text{Value of Basket in Current Year}}{\text{Value of Basket in Prior Year}}\times 100\end{aligned}AnnualCPI=ValueofBasketinPriorYearValueofBasketinCurrentYear×100

As mentioned earlier, the basket of goods and services used in the CPI calculation is a composite of popular items commonly purchased by Americans. The weight of each component of the basket is in proportion to how they are sold. The annual CPI is reported as a whole number, and the figure is often greater than 100 (assuming current market prices are appreciating).

Then, the BLS uses the current year's CPI and the prior year's CPI to calculate the inflation rate.

\begin{aligned}\text{Inflation Rate} = \frac{\text{New CPI} - \text{Prior CPI}}{\text{Prior CPI}}\times100\end{aligned}InflationRate=PriorCPINewCPIPriorCPI×100

The inflation rate can be calculated for a given month or annual period; in either case, the appropriate new and prior period must be selected. The inflation rate is reported as a percentage and is often positive (assuming current market prices are appreciating).

CPI Categories

The monthly CPI release from the BLS leads with the change from the prior month for the overall CPI-U as well as its key subcategories, along with the unadjusted change year-over-year. The BLS detailed tables show price changes for a variety of goods and services organized by eight umbrella spending categories.

Subcategories estimate price changes for everything from tomatoes and salad dressing to auto repairs and sporting events tickets. Price change for each subcategory is provided with and without seasonal adjustment. In addition to the national CPI indexes, BLS publishes CPI data for U.S. regions, sub-regions, and major metropolitan areas. The metro data is subject to wider fluctuations and is useful mainly for identifying the price changes based on local conditions.

The table below represents the CPI basket weighted distribution amongst the eight major expense categories. Be mindful that some subcategories may be difficult to spot within their major categories. For example, automobiles are classified under commodities.

Article Sources

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1. U.S. Bureau of Labor Statistics. "Handbook of Methods for Consumer Price Index: Data Sources."

2. American Economic Association. "CPI Housing Survey -- BLS Invites Comments."

3. U.S. Bureau of Labor Statistics. "Consumer Price Indexes Overview."

4. U.S. Bureau of Labor Statistics. "Consumer Price Index Frequently Asked Questions."

5. U.S. Bureau of Labor Statistics. "CONSUMER PRICE INDEX - DECEMBER 2022," Page 1.

6. U.S. Bureau of Labor Statistics. "Consumer prices up 7.1 percent over year ended November 2022."

7. U.S. Bureau of Labor Statistics. "Consumer Price Index - November 2022," Page 8.

8. Board of Governors of the Federal Reserve System. "FAQs."

9. U.S. Bureau of Labor Statistics. "Schedule of Releases for the Consumer Price Index."

10. Federal Reserve. "Coronavirus Disease 2019 (COVID-19)."

11. U.S. Bureau of Labor Statistics. "The Employment Situation - August 2022."

12. U.S. Bureau of Labor Statistics. "Consumer Price Index Data Quality: How Accurate Is the U.S. CPI?"

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