The Consumer Price Index – October 2001
1. What is the Consumer Price Index?
The Consumer Price Index (CPI) is a measure of the
average change in the prices paid by consumers for a specific
basket of goods and services over time. This “shopping
basket” represents a mix of consumer goods and services
purchased by the average household. The importance (or weight)
of each item in the “basket” is determined by
the amount spent on them by households.
2. Why is the CPI Important?
The CPI is important because many of its applications
affect most persons in some way. The CPI is used by employers
and other agencies for the adjustment of wages and salaries;
by labour unions in collective bargaining; by economists as
a guage for assessing the current performance of the economy;
as a measure of inflation and by government in formulating
and evaluating many economic policies. 
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3. How is the Basket Created?
The items in the “basket” are determined
from information obtained from Household Income and Expenditure
surveys conducted by the Central Statistical Office. During
a specified period, a predetermined number of households from
around the country provide information on their spending habits
by maintaining a diary of everything bought during that specific
period.
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This information is used to update the “basket”
on which the CPI is based. This update allows for new goods
and services that have become significant in households’
budgets, like Internet Service, to be included in the “basket”,
and other items which have lost importance to be excluded
or have their weights reduced.
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Once the “basket” is set up, the quality and
quantity of the items in the basket are kept constant. However,
the total cost of this “fixed basket” will vary
from one period of time to another, as the prices of the items
in the “basket” change. Price changes resulting
from such a “constant or fixed basket” are defined
as “pure price” movements, which is what the CPI,
in essence, measures. The “All Items” index therefore
gives in a single figure the percentage change in the cost
of purchasing the contents of the “basket” over
a period of time.
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4. How are the Weights Determined?
The amount spent on each item in the CPI “basket”
is compared to total household spending to obtain the relative
importance or “weight” of the commodities in the
“basket”. The major categories of the CPI each
have representative “group weights”. These weights
establish the impact that a particular price change within
each category will have on the overall index. For example,
a 5 percent rise in the price of cooking gas would have a
much greater impact on the household budget than a 5 percent
increase in the price of newspapers. This is due to the fact
that households spend more on cooking gas than they do on
newspapers. Table 1 shows the various weights applied to the
categories for each of the eight member countries of the Eastern
Caribbean Currency Union.
Table 1
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5. How are Prices Collected for
the CPI?
The CPI is designed to measure price changes for a fixed basket
of goods and services. Price movements must be monitored in
several retail outlets from which households do their shopping
and also from various business organisations which provide
services to households. Monthly prices are collected from
outlets such as supermarkets, shoe stores, doctors and beauty
parlours. Additionally, price data for bus, ferry and taxi
fares, telephone and electricity charges, education and hospital
charges are collected from the appropriate authorities.
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6. How is the CPI calculated?
Once the prices of goods and services have been collected,
they are scrutinised to ensure validity of the data. Prices
are compared with the previous month’s data in order
to monitor price fluctuations and maintain consistency from
month to month. The prices are also compared to the price
in the base period, which in this instance is January 2001
for all countries except Anguilla, which uses December 2000.
The following steps are used by the Statistical Office in
calculating the Consumer Price Index:
Step 1: Collect the prices for the items
that make up each category in Table I.
Step 2: Calculate the price relative to
determine whether the price has increased or decreased relative
to the previous month. (Divide the current month’s average
price by the previous month’s average price).
Step 3: Derive the current month’s
cost. (Multiply the price relative by the previous month’s
cost for the specific items )
Step 4: Derive the price index for each
category. (Divide the current month’s cost derived in
Step 3 by the base period’s (January 2001) cost and
multiply by 100.
What this means is that in March 2001 it costs $104.75 to
buy the same quantity of bakery products that costs $100.00
in January 2001.
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Step 5: Compute all the items in each sub-index
in the same manner (Steps 1 through 4) and then sum and average
all items under each sub-index to obtain an aggregate index
for that sub-index. For example, under the sub-index “food”,
the indices for bakery products, fish, fresh meat etc, are
summed and averaged to obtain an aggregate index for the sub-index
“food”.
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Step 6: Weigh each sub-index according to
the weight assigned for each of the eleven sub-indexes. This
represents all goods and services in the “basket”
as the “All Items” index and provides the basis
upon which inflation can be measured.
Table 2
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7. How is the CPI interpreted?
An index is a tool that simplifies the measurement
of movements in a series of numbers. The index for the reference
period for the CPI is set to 100 and changes in prices are
measured in relation to this figure. An index of 104.75, using
the index for bakery products as an example, means there has
been a 4.75 per cent increase in price since the reference
period January 2001. Similarly, an index of say, 90 means
a 10 percent decrease since the reference period.
Changes between the “All Items” index for comparative
periods will give the inflation rate for that period. For example
if the “All Items” index is 156.5 and 167.5 for
June 2001 and July 2001 respectively, then the inflation rate
at July 2001 is 7.03%
8. Why Update the CPI?
As long as there are significant changes in consumer buying
habits, introduction of new goods and services (computers
and internet) or shifts in the population distribution and
composition (immigrants with varying cultures), then a change
in the CPI is needed. Table III below shows the various base
periods that were previously used by the countries.
9. Why a Harmonised Consumer Price
Index?
Since the member countries of the Eastern Caribbean
Currency Union (ECCU) use the same currency, it is also necessary
to have the ability to compute an Index that represents all
of them collectively and this can only effectively be done
if they all use a similar base period. Further, as the member
countries of the OECS move towards a common market, close
monitoring of the inflation rate of the ECCU will become necessary.
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| It is important
to understand that the market baskets and pricing procedures
used for the CPI in member countries represent the experience
of the 'average' household, not of any specific family
or individual. |
|
CPI Questions and Answers
