Consumer Price Index (CPI)4 min read
Calculation of CPI
The Consumer Price Index is also known as CPI. It is one of the macroeconomic inflation indicators. In this article, we will see the Consumer Price Index meaning CPI, the basket of goods and services under CPI and their respective weights, and the method of how is CPI calculated in India.
What is the Consumer Price Index (CPI)?
Consumer Price Index (CPI)
CPI meaning Consumer Price Index, measures changes in the general level of prices of goods and services that households acquire for consumption. CPI is designed to measure changes in the retail prices of selected goods and services on which consumers of a defined group spend their incomes over some 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 from a given money expenditure. In simple words, it measures changes in the price level of fixed consumption CPI goods basket and services purchased by households. Such changes affect the real purchasing power of consumers’ income and welfare.
Proposed Groups of a basket of goods and services under CPI are as follows :
Basket of Goods & Service under CPI
Segmentation of CPI :
In defining a Consumer Price Index, the scope and coverage of the index should be clearly explained. It should specify the population group covered, such as urban wage earners, and the geographical area covered, such as a city, a well-defined industrial site, or a state. In India, the above-mentioned segment-specific CPIs are regularly compiled and published separately.
The CPI components are as follows-
1. CPI for Industrial Workers (IW):
It covers industrial workers employed in any one of the seven sectors, namely factories, mines, plantations, railways, public motor transport undertakings, electricity generation and distribution establishments, and ports and docks. The index covers only manual workers irrespective of their income.
2. CPI for Agricultural Labourers (AL):
A person is treated as an agricultural labourer if they follow one or more of the farming occupations in the capacity of a labourer on hire, whether paid in cash or kind or partly in cash and partly in kind.
3. 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.
4. CPI for Urban Non-Manual Employees (CPI UNME):
An urban non-manual employee is defined as one who derives 50 per cent or more of their 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 the national level. At the same time, 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 the population in the country
Calculation of Consumer Price Index
Compilation of CPI Numbers has 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 a higher-level index using the information on each elementary aggregates’ expenditures as weights.
For calculating CPI, two requisite components are:
- Weighting Diagram (Consumption Patterns)
- Price data collected at different intervals
Items are first classified, organised and coded according to Groups, Sub Groups and Categories. Then a Weighing Diagram is prepared.
What is a Weighting Diagram?
The 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 preparation of weighting diagrams. The non-consumption cost has been excluded. After excluding non-consumption expenses from the average monthly consumption expenditure, the remaining items were classified into several consumption groups and subgroups.
- To calculate the 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 collection 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 a crude total.
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, mainly where there is a need to reflect substitution within the elementary aggregate or where the dispersion in prices or price changes within the crude total is large. The elementary/item indices are computed using the Geometric Mean (GM) of the Price Relatives of Current Prices regarding base prices of different markets. GM has many advantages because of its mathematical properties.
Consumer Price Index Formula Macroeconomics
To calculate the CPI for any given year, divide the cost of a specific market basket in that year by its cost in the base year.
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