What Is the Consumer Price Index? Definition and Importance
The Bureau of Labor Statistics (headquarters pictured here) calculates the CPI every month, and investors and analysts use changes in CPI to gauge the rate of inflation.
What Is the Consumer Price Index (CPI) in Simple Terms?
The consumer price index is essentially a collection of average current prices of common goods and services weighted according to available data about consumption. The resulting figure changes over time, and how much it changes over a specific period of time can offer insight into the rate of inflation (or deflation) over that period.
In the same way that a researcher selects a sample of test subjects to experiment on in the hope that that sample is a fair representation of the total population they wish to study, the Bureau of Labor Statistics selects a sample of goods and services thought to be representative of common products and services at large. The prices within each product category are averaged, then those averages are weighted according to how much of a person’s total spending would likely be dedicated to each category.
By examining the degree to which this weighted average changes, we can see how quickly the cost of living has changed over the last month, quarter, year, or decade. For instance, “from 2019 to 2020, consumer prices for all items rose 1.4 percent” according to the BLS.
Note: The Bureau of Labor Statistics calculates many different CPIs designed to track different product types, populations, and regions. Unless otherwise noted, for the purposes of this article, we are discussing the CPI titled “All items in U.S. city average, all urban consumers, not seasonally adjusted.”
How Does the CPI Relate to Inflation?
The CPI is one of the most popular metrics used to estimate the rate of inflation. Since the CPI is updated and reported monthly, it can be used to estimate the rate of inflation over as short a period as a single month.
How to Calculate Inflation Using the CPI
To calculate an estimated rate of inflation over a particular period of time, simply subtract the older CPI from the more recent, then divide the result by the former and multiply by 100.
Let’s say we wanted to calculate the rate of inflation from January 2015 to January 2020. First, we’d need to gather the CPI values for each of those dates. Then, we can calculate the rate of inflation over that five-year period.
January 2015 CPI-U: 233.707
January 2020 CPI-U: 257.971
Rate of Inflation (Jan. 2015–Jan. 2020) = (257.971 – 233.707) / 233.707
Rate of Inflation (Jan. 2015–Jan. 2020) = 24.264 / 233.707
Rate of Inflation (Jan. 2015–Jan. 2020) = 0.1038
Rate of Inflation (Jan. 2015–Jan. 2020) = 10.38%
So, the rate of inflation between January 2015 and January 2020—as estimated by the CPI—was 10.38 percent.
How Is the CPI Calculated?
The CPI mentioned above is calculated (more or less) like this: The BLS collects and averages current prices for a number of similar products within a category (e.g., cans of black beans or gallons of gas). The average for each category is then assigned a weight (i.e., a percentage share of the index) based on the average proportion of consumer spending it is thought to represent. The categories are then averaged according to their respective weights. The resulting number can then be compared to those of previous months, years, or decades.
The CPI was originally created such that it would equal 100 for the period from 1982 to 1984. Thus, 100 can be subtracted from the CPI for any subsequent year, and the result is the rate of inflation since 1984. As of October 2021, the CPI was 276.589, meaning goods and services had gone up in price by an average of about 176.589% since 1984.
What Does the CPI Actually Measure?
The CPI doesn’t measure inflation or the cost of living directly. Instead, it compiles, averages, and weighs the current prices of an array of products and services within categories that are thought to be representative of typical consumer spending patterns. In this sense, CPI is more of an estimation of the cost of living than a direct measure of it.
What Product and Service Categories Are Included in the CPI?
The BLS samples over 200 product and service categories when compiling the CPI, but each of these 200 categories generally falls into one of eight major groups:
- Food and beverages
- Housing
- Apparel
- Transportation
- Medical care
- Recreation
- Education and communication
- Other goods and services
How Are the Product and Service Categories Included in the CPI Determined?
The BLS bases the product categories (and their weights within the index) on real spending data provided by real individuals and families about their real-world shopping habits and routine expenditures. That being said, the people surveyed for this information represent only a small fraction of the U.S. population. Additionally, gathering data takes time, so CPI inclusions are usually based on survey data that is one to three years old.
According to the BLS, “CPI data in 2020 and 2021 was based on data collected from the Consumer Expenditure Surveys for 2017 and 2018. In each of those years, about 24,000 consumers from around the country provided information each quarter on their spending habits in the interview survey.”
CPI vs. PPI: What's the Difference?
The CPI measures the average cost of goods and services purchased by consumers (a.k.a. end-users) in the U.S. In other words, it is a calculation of the estimated value of products and services at their final destination—the consumer. For this reason, it includes imported products and services, and sales tax is included in its component prices
The producer price index (PPI), on the other hand, measures the cost of goods and services when they first leave their origin—when they are sold wholesale by their producers (usually to other businesses, often many steps before they reach consumers). Sales tax is not included in the PPI’s component prices, and imports are omitted because the PPI only takes domestic-produced products into account.
Note: PPI and CPI do have some overlap, as certain products and services are sold directly from U.S. producers to U.S. consumers.
Frequently Asked Questions (FAQ)
Below are answers to some of the most common questions investors have about the CPI that were not already addressed in this article.
What Are the Two Main CPIs?
The CPI mentioned above (the index for all urban consumers) is designed to represent 93% of the total U.S. population, including individuals who are employed, self-employed, unemployed, and retired.
The BLS also compiles a second CPI designed to represent only urban wage earners and clerical workers, who make up approximately 29% of the total U.S. population. This group is a subset of the main population that is sampled to create the CPI for all urban consumers mentioned above.
What Does It Mean When the CPI Changes?
When the CPI goes up over time, it means that the cost of living is going up. In other words, inflation is occurring. If, on the other hand, the CPI goes down over time, this indicates that the cost of living is going down, or that deflation is occurring.
Can CPI Be Negative?
The CPI can certainly go down over time, so a change in CPI can be negative, but since it is a measure of weighted average prices, and prices are always positive, the CPI itself cannot be negative.
When Is the Updated CPI Released?
Each month, usually on or around the 15th at 8:30 am Eastern time, the BLS releases CPI values for the previous month.
Are Price Indexes Similar to Stock Indexes?
Price indexes are similar to stock indexes in that both track the average prices of a collection of items over time, and both weigh component items based on some factor or another.
Many stock indexes weigh component companies by market cap (a measure of company size), whereas price indexes weigh component product and service categories by their presumed share of an average citizen’s spending. Both are used as economic indicators and benchmarks.