Consumer prices are changing over time due to the various factors. In order to compare the economic performance on the different levels it is necessary to establish the specific index pointing out the overall tendency of the changes. The Consumer Price Index is commonly used all over the world. That is why it is important to analyze the main principles of its application and identify this term in details. The ways of calculation of this index are slightly different in different countries. Therefore we shall thoroughly discuss the means of the comparison applied by national economies of different origin. The historical approach to the considering of this index shall be emphasized.
The meaning and main functions of the Consumer Price Index
Consumer Price Index (CPI – is the economic index, which measures monthly or quarterly the dynamics of prices of the consumer goods and services. Prices are registered by stores or other retail outlets. The usual method is to calculate the average price changes for different products for one period compared with the previous, using as basis the average amount of money spent by households to purchase them.
CPI is the official statistics prepared by the national statistics agencies, ministries of labour or main banks of the countries. The CPI is published within approximately ten days after the end of the month or quarter. The CPI measures the price inflation considering the households acting as consumers. It is also widely used as the substitute for the General Index of Inflation for the economy as a whole system partially because of the frequency and timeliness of its publication. CPI has become an essential statistic for the process of the economic decision-making, particularly in the area of monetary policy.
It is often referred to in the legislation and in many private contracts as the measure of inflation that should be used for adjusting payments (such as wages, rent, interest payments and social insurance benefit) taking into account the influence of inflation. In this regard, the use of the CPI can have significant and large-scale financial implications for state bodies and businesses and for households. In most countries the CPI appears to have acquired the unique status in the field of economic statistics. This can be explained by influence of several factors. First of all, all households experience specific phenomena that the CPI purports to measure. The general public is informed of the changes in the prices for consumer goods and services and the direct impact that these changes have on the living standards. Not only the media and political circles are interested in knowledge of the price changes but many people that are on different levels of society.
The change in the CPI is usually actively considered by the public. The publication of the index can be observed through the main news. CPI belongs to the category of highly visible statistics. The CPI is regularly published, which allows monitoring the level of consumer inflation thoroughly. In addition, the CPI represents the operational statistics published shortly after the end of the period to which they relate. The CPI is the statistical indicator with a long history. The population is familiar with it for the long period of time. Although changes in the prices of some goods and services are difficult to measure because of changes in their quality, even greater difficulties arise in the measurement of the dynamics of prices for other goods and services, such as investment goods and government, and especially the collective services. The CPI can serve as relatively reliable price index compared with the price indexes of some other forms.
The CPI is widely acknowledged. Its accuracy and reliability rarely causes serious bias. In most countries the rule according to which the index is not revised after its publication are deliberately adopted. That makes it more convenient for application in many, especially financial significant purposes, such as indexing. Perhaps the rejection of the clarification creates somewhat false impression about the reliability of the index. But apparently it also increases the credibility of the index and its degree of acceptability.
The widespread use of CPI for the different tasks can be explained by the mentioned above and the absence of any other acceptable alternative or better indicators of the monthly rate of inflation in most countries. The CPI can be used instead of the more common measure of inflation in commercial accounting, despite the fact that, by its nature, this index is obviously not ideal for this purpose. The fact that CPI is not subject to revision along with the regularity and timeliness of its publication explains its popularity as the means of indexing of the commercial and legal contracts. The argument in defense of such practices is the fact that the alternative to the use of the CPI is the absence of any adjustments for inflation. Although the CPI is not the ideal measure of inflation, this index is preferred to be applied by the vast majority of the countries.
The CPI is often used instead of the overall rate of inflation, but this fact does not explain the excessive expansion of its scope to include elements that go beyond household consumption. Indeed, some countries are developing additional and more comprehensive indicators of inflation within the conceptual framework.
The implementation of the CPI within the historical framework
The accuracy of method of determining the CPI to the large extent depends on actors by whom the index will be used. The CPI was created in the eighteenth century. The indexes of Laspeyres and Paasche, which are still widely used at present, were firstly proposed in the 70-ies of the nineteenth century. The concept of living-cost index was introduced in the early twentieth century.
Traditionally one of the main reasons for the compilation of the CPI is the need to compensate salaries for the employees for the losses caused by inflation by adjusting their wage rates in proportion to the percentage change in the CPI. This procedure is known as indexing. In this regard the responsibility for compiling the official CPI had previously been entrusted to the Ministry of labour, although at present these indexes in most cases are compiled by national statistics agencies. The specially designed for wage indexation CPI is called to be the index of compensation.
The CPI is commonly used as the proxy for the general level of inflation, despite the fact that it measures only consumer prices. It is also used by some governmental institutions or central banks in order to determine the inflation target of monetary policy. Since the CPI provides the opportunity to obtain operational information about the level of inflation, it started to be applied for several other purposes in addition to indexing wages. The CPI is widely used to indexing pensions and social security benefits. The CPI is also used for indexing of other payments, such as interest payments, rents, or prices of bonds.
The calculation of CPI
There are various techniques applied to the calculation of the CPI. But the most commonly applied ways of calculations are based on the establishing of the so-called weights. For example, in USA the index of consumer prices is calculated by considering the prices for 265 goods and services in 85 cities of the country. The important role of the consumer price index implies the need to create the single approach for the calculation methods of this indicator, which would reflect the rate of change of the price level.
For example, when calculating the CPI will take into account only limited number of goods that are related to the minimum level of consumption. On this basis, the price index will be much smaller and the growth in wages does not compensate the inflation, which can affect the reduction of incentives to work. The basic formula applied for the calculation of the CPI is as following. It shows the CPI increase for the period of five years.
The products and services of the CPI consumer basket are divided into more than 200 categories. They are classified into the following basic groups such as food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, other goods and services.
As we have mentioned above the Consumer Price Index has different methodologies of calculation that significantly influences the final results. Nevertheless it is important to take into account some factors that may cause the calculation bias. The framework of the country and particular peculiarities of its economic environment can also change the accuracy of the calculation.
Conclusions
The CPI is the statistical indicator reflecting the dynamics of the cost of the fixed set of goods and services, and can serve as the main indicator of inflation. CPI characterizes the time variation of the general level of prices for goods and services purchased by the population for non-productive consumption. The CPI is designed to achieve the following objectives: estimate inflation, indexing of the income, establishing current costs of production, regulation of the real exchange rate of the national currency.
The CPI used in the recalculation of macroeconomic indicators from current prices to constant prices. There are problems associated with the calculation of core inflation. Special attention should be paid to improving the monitoring of producer prices of agricultural products, prices of industrial products purchased by agricultural organizations, as well as consumer prices for food products that will help to identify the degree of influence of individual market participants on the level and dynamics of prices of final products in general. As the result of this research it is necessary to mention that the stated objectives are achieved and the CPI is thoroughly analyzed focusing on the most significant aspects of its application.
References
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Peter Kanz, R. D. (2011). How to measure the changes in consumer prices. London: Economic Press.
Peterson, E. (2015). The measuring of living. Brooklyn.
Weber, K. (2013). The principles of the modern economy. New York: NNP.
