What is the Consumer Price Index?

Mary McMahon
Mary McMahon

The consumer price index (CPI) is an index which tracks changes in prices for basic goods and services. Consumer price indices are calculated regionally, reflecting the fact that prices are rarely stable across a nation. They are commonly used to measure inflation, and they may be utilized in other ways as well. As a general rule, the consumer price index is always on the rise, especially in a healthy economy.

For the consumer, inflation lowers the value of currency, as the cost of what they buy goes up.
For the consumer, inflation lowers the value of currency, as the cost of what they buy goes up.

To determine the consumer price index, government economists use what is known as a “market basket.” The market basket is a sampling of common goods and services. This is averaged to determine whether the cost of living is rising or falling in a given area. Economists may also track trends within the market basket. For example, they may note that food prices are rising very rapidly, and they can adjust the weighting of the consumer price index to compensate for this.

The Federal Reserve constantly monitors for inflationary risks to the U.S. economy, and may respond with actions or policies to try to stave off price increases.
The Federal Reserve constantly monitors for inflationary risks to the U.S. economy, and may respond with actions or policies to try to stave off price increases.

Prices naturally fluctuate over time, and the CPI is usually calculated seasonally to smooth out some of the normal changes which occur over the course of the year. If prices appear to be rising very fast, it indicates that the economy is experiencing a period of inflation. While low-scale inflation can be beneficial, rapid inflation can put consumers in a position where their wages do not keep pace with the consumer price index, making it difficult to live.

When prices drop, it reflects deflation. Deflation is often regarded as a negative for the economy, especially if it persists. However, sometimes deflation is the result of a natural market contraction after a bubble has burst. In this case, it might indicate that the market is correcting itself, and prices will eventually stabilize and start to rise again.

Statistics on the consumer price index can be found through government agencies which are responsible for keeping track of economic growth. Many such agencies keep their records online, and consumers can access very old records if they are interested in tracking changes in the CPI which have occurred over decades. It's important to remember that fluctuations from season to season can be less indicative than changes spread over a longer period of time.

As a general rule, wages and government benefits do not keep pace with inflation, because it can take time to enact changes. A spike in the consumer price index can result in hardship for citizens who are receiving wages and benefits which may be pegged to older prices.

The CPI measures inflation by averaging the cost of the products average consumers buy each month.
The CPI measures inflation by averaging the cost of the products average consumers buy each month.
Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

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Discussion Comments

Melonlity

@Terrificli -- Keep in mind that home prices drop only temporarily. The historical trend pushes them upward over time. It is not unusual to see price dips from time to time, but the overall trend is that houses increase in value in the long run.

In that example, I'm not sure we are talking about true deflation at all. The drops are temporary, but homes always seen to gain in value. The day the trend points to homes losing value in the long run is the day we know our economy is an absolute mess.

Terrificli

Market deflation is, indeed, a natural way for the economy to correct and heal itself. Take the housing industry, for example. If prices went up constantly, would most people be able to afford a home? When prices get too high, they will drop so they will be back in line with what consumers can afford.

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