How is CPI Used: Meaning, Working and Process

cpi

Consumer Price Index (CPI) is a metric used for determining an economy's inflation level. CPI measures retail inflation by collecting data on the increased costs of goods and services used by the citizens of a country. Besides, CPI is widely used to compute the cost of living of the inhabitants, and it also assesses the changes in the purchasing capacity of a country's currency. If you are still wondering how CPI is used, keep reading to get an in-depth concept.

How Is CPI Used?

The type of calculation involved during the estimation of CPI is quite complicated. Different categories and sub-categories are made to segregate the consumption items based on consumer groups, including urban and rural inhabitants. The national statistical organisations compute the final overall price index based on these indices and sub-indices.

In recent times, CPI has become the most prevalent method to analyse price inflation and is applied as a macroeconomic indicator by the Indian Government and the Reserve Bank of India (RBI). They use CPI to determine price inflation and plan their economic rules and strategies accordingly.

Which Agencies Uses CPI to Take Economic Decisions?

Mentioned below is the list of eight agencies that use the Consumer Price Index (CPI) to predict inflation and take economic decisions:

  • Attire
  • Food and Drink
  • Housing
  • Education
  • Healthcare
  • Transportation
  • Communication
  • Leisure

If you are wondering how CPI works, look at the easy steps to calculate the consumer price index.

What Is the Step-by-Step Process to Calculate the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) is one of the most vital statistics for an economy which is usually based on the weighted average of the costs of goods. This metric helps calculate inflation based on the rates of price changes for products and services over a given period. Mentioned below are some easy steps to calculate the consumer price index.

Step 1: Gather Prices for Certain Products and Services from the Past

First, conduct thorough research online on the prices of some products and services from last year. Also, collect information from their bills and receipts for purchases made earlier. Also, make sure that you gather information about their demand in the preceding year.

Step 2: Gather Prices for Current Products and Services

After collecting information about the demand and prices of certain goods and services from last year, carry out the same procedure for the current year. Also, if necessary, check the prices of the goods from similar brands to make a better comparison.

Step 3: Sum Up All Prices Together

After this, add all the prices of previous goods and services and jot down those numerals. In the same way, add all the prices of products bought in the current year.

Step 4: Divide Total Present Product Price by Total Past Product Price

After jotting down the addition of the entire goods price from the preceding and prevailing year, divide the total current product price by the total past product price.

Step 5: Multiply the result by 100

Once you get the values from the last step, multiply the numeral by 100 to get the exact Consumer Price Index (CPI).

To get a better elaboration, check out the formula to calculate the CPI in an economy.

Consumer Price Index (CPI) = (Cost of Fixed Basket of Goods and Services in Current Year/Cost of Fixed Basket of Goods and Services in Base Year) X 100.

Remember that this formula only applies to figure out the inflation rate once you have computed the Consumer Price Index for two years.

An Example Showing the Computation of Consumer Price Index (CPI)

The formula to calculate Consumer Price Index in an economy is:

CPI = Cost of market basket in the current year/Cost of market basket in the base year X 100

Suppose that the cost of market basket in the present year is ₹11.50 and cost of market basket in the base year is ₹8.75.

Then, the equation will stand at ₹11.50 / ₹8.75 = 1.32

After this, multiply this number by 100, which will be 1.32 X 100 = 132

Now, deduct this numeral from 100 in order to get the final percentage of change, i.e. 32%.

Thus, there is total 32% change in product prices since the base year.

What Are the Uses of Consumer Price Index (CPI)?

There are several uses of CPI that can cause either a direct or indirect impact on financial life. Mentioned below are three common uses of Consumer Price Index (CPI).

To Measuring Inflation

Inflation signifies an escalation in prices which causes adverse effects on purchasing power of individuals. With a price increase, your money cannot do much since you must pay more while buying your desired product or service. CPI helps to point out the level of inflation within an economy alongside their current trending, consumer behaviour, the average change in the price of goods over time, etc.

To Measure Deflation

Unlike inflation, CPI also helps measure deflation, which also affects a country's economy. During this phase, the costs of products and services fall significantly, and inflation goes below 0%. As a result, the purchasing capacity of consumers starts to upsurge, and the supply of money starts to fall.

To Adjust Cost-of-Living

The Consumer Price Index (CPI) also helps adjust Cost-of-Living. This cost of living index comprises food, shelter, energy, healthcare, transportation, clothing, childcare, and more. The cost-of-living index helps determine Social Security benefit amounts and compares expenditures from one location or geographic region to another. This adjusted cost of living data obtained from CPI helps employers increase the salaries paid to workers.

In a nutshell, Consumer Price Index is a term used to measure inflation in an economy. Since CPI determines the value of money, it sets a particular base for every transaction. Knowing how CPI is used may help consumers and businesses to foresee an inflationary situation and make well-versed economic decisions.

FAQs About How CPI Is Used

Who is responsible for computing CPI in India?

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The Ministry of Statistics and Programme Implementation (MoSPI) and Price Statistics Division (PSD) of the National Statistical Office (NSO) are involved together to calculate and determine the Consumer Price Index (CPI) for rural, urban, and various sectors in India.

What are the limitations of Consumer Price Index (CPI)?

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The following are some demerits of Consumer Price Index (CPI):

  • CPI does not determine the price changes in rural, urban, or remote areas.
  • It cannot compute variations across two different areas.
  • CPI does consider the differences in spending habits between individual households.

What are the different types of CPI?

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The Consumer Price Index (CPI) has been classified into four different types, which comprise CPI for Industrial Workers (CPI-IW), CPI for Rural Labourers (CPI-RL), CPI for Urban Non-Manual Employees (CPI-UNME), and CPI for Agricultural Labourers (CPI-AL).

What is the present-day CPI in India?

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According to a current report, the Consumer Price Index CPI increased to 6.52% in January 2023.

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