Consumer Price Index (CPI)
Calculation of CPI
Consumer Price Index (CPI) is one of the macroeconomic indicators of inflation. In this article, we will see what is CPI, what are the basket of goods aand services under CPI and their respectiev weights, calculation of CPI.
What is Consumer Price Index (CPI)?
- Consumer Price Index (CPI) measure changes over time in general level of prices of goods and services that households acquire for the purpose of consumption.
- CPI is designed to measure changes in the level of retail prices of selected goods and services on which consumers of a defined group spend their incomes over a period of time.
- The changes in consumer prices affect the real purchasing power of households’ money incomes and hence, the standard of living or welfare that they can achieve out of a given money expenditure.
- In simple words, it measures changes in the price level of a fixed consumption basket of goods and services purchased by households. Such changes affect the real purchasing power of consumers’ income and welfare.
- Proposed Groups of basket of goods and services under CPI are as follows :
Segmentation of CPi :
- In defining a Consumer Price Index, the scope and coverage of the index should be clearly explained. For example, it should specify the population group covered, say, urban wage earners, agricultural laboureres, rural population, etc. The geographical area covered e.g. a particular city, a well-defined industrial area or a state should also be specified in respect of a Consumer Price Index.
- In India, the above mentioned segment specific CPIs are being compiled regularly and published seperately. They are as follows-
- CPI for Industrial Workers (IW) : It covers industrial workers employed in any one of the seven sectors namely factories, mines, plantation, railways, public motor transport undertakings, electricity generation and distribution establishments as well as ports and docks. The index covers only manual workers irrespective of their income.
- CPI for Agricultural Labourers (AL) : A person is treated as an agricultural labourer if he or she follows one or more of the agricultural occupations in the capacity of a labourer on hire, whether paid in cash or kind or partly in cash and partly in kind.
- CPI for Rural Labourers (RL) : A rural labourer is defined as one who does manual work in rural areas in agricultural and non-agricultural occupations in return for wages in cash or kind, or partly in cash and partly in kind.
- CPI for Urban Non-Manual Employees (UNME) : An urban non-manual employee is defined as one who derives 50 per cent or more of his or her income from gainful employment on non-manual work in the urban non-agricultural sector.
- First 3 CPIs viz. CPI(IW), CPI(AL) and CPI(RL) are compiled by the Labour Bureau in the Ministry of Labour and Employment at national level, while the fourth one CPI(UNME) is released by the Central Statistical Organization in the Ministry of Statistics and Programme Implementation.
- These CPIs reflect the effect of price fluctuations of various goods and services consumed by specific segments of population in the country
Calculation of Consumer Price Index
- Compilation of CPI Numbers Four requirements :
- Selection of Base Year
- Item Weights : Working Class Family Income & Expenditure Surveys and derivation of weighting diagrams
- Base Prices : Organization of Price Collection work
- Current Prices : Regular collection of Prices and their processing
- Calculation of a consumer price index (CPI) proceeds in two or more stages.
Stage 1 : In the first stage of calculation elementary price indices are estimated for the elementary expenditure aggregates of a CPI.
Stage 2: In the second and subsequent stages these elementary price indices are combined to obtain higher-level indices using information on the expenditures on each of the elementary aggregates as weights.
- For calculating CPI, two requisite components are:
- Weighting Diagram (Consumption Patterns)
- Price data collected at different intervals
- Items are first classified, organized and coded according to Groups, Sub Groups and Categories. Then a Weighing Diagram is prepared.
What is Weighting Diagram?
- Weighing diagram gives the share of each item in the total consumption expenditure in a Consumer Expenditure Survey(CES). Only consumption expenditure has been considered for the purpose of preparation of weighting diagrams. Non-consumption expenditure has been excluded. After exclusion of non-consumption expenditure from the average monthly consumption expenditure, the remaining items were classified into several consumption groups and subgroups considering Classification of Individual Consumption, the standard international classification as well as present classification of items adopted in the existing CPI numbers compiled at national level.
- For calculation of Consumer Price Index (CPI), prices are collected from 1181 village markets covering all districts and 1114 urban markets distributed over 310 towns of the country.
- The elementary aggregate is the smallest and relatively homogeneous set of goods or services for which expenditure data are defined (used) for CPI purposes. The set of goods or services covered by an elementary aggregate should be similar in their end-uses and are expected to have similar price movements. An elementary index is a price index for an elementary aggregate.
Averaging of Relative Prices
- There are several ways in which the prices or the price relatives might be averaged. It is recommended that the geometric mean (GM) method be used, particularly where there is a need to reflect substitution within the elementary aggregate or where the dispersion in prices or price changes within the elementary aggregate is large.
- The elementary/item indices are computed using Geometric Mean (GM) of the Price Relatives of Current Prices with respect to Base Prices of different markets. The GM has many advantages because of its mathematical properties.