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Inflation is an economic phenomenon that increases the cost of goods an individual needs to live and maintain a certain standard of living. Classically defined, inflation is too many dollars chasing too few goods, tracked each quarter using the consumer price index (CPI). A major concern with CPI calculations is that they do not actually account for real CPI. Real CPI is the actual change in price for goods a consumer purchases, not the fictional basket of goods economists put together to compute CPI. Individuals can calculate a true CPI figure by dividing the current price by a base year and multiplying by 100 to get a real inflation figure.
An example of real CPI is to determine how much the price of housing has changed in five years. In a specific year, the median price was $150,000 US Dollars (USD) for a certain house type in a specific region. Median housing prices for the same type and region five years later were $168,000 USD. The CPI calculation divides 168,000 by 150,000 and multiplies the result by 100, giving an answer of 12 percent. Therefore, the real inflation for housing during this period is 12 percent, versus the reported CPI from economists using their formula.
In most cases, the reported CPI figures from economists or national governments in stable free markets are often under 10 percent. As the example above states, however, this cannot be true if housing prices increased by 12 percent for the given time. Real CPI attempts to strip the bias and faulty computing for CPI from standard inflation formulas. For example, economists may add weights to the different categories of their inflation formulas. This can skew the result of real CPI as reported by the true, unadulterated figures computed based on actual prices for items.
Another use of real CPI is to measure the price changes for substitute goods or those most often purchased by consumers. Standard CPI calculations take a standard basket of goods, even though consumers may not purchase these items. Substitute goods are the items a consumer purchases when incomes fall or purchasing power decreases. The demand for these goods should make them of special interest for economists calculating inflation. Unless these goods have inclusion in standard CPI computations, then real CPI is not being measured correctly.
Real CPI is not a cost of living index or adjustment (COLA). The way economists put together their inflation formulas, however, make it work like a COLA. This is one of the biggest reasons consumers do not have information on the true figures for inflation.
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