The CPI Inflation Measure- Constructing and Calculating a CPI Index Flashcards
(28 cards)
What is inflation?
A persistent increase in the general price level of goods and services in an economy over time.
What does CPI stand for, and what does it measure?
CPI = Consumer Price Index. It measures the average change in prices of a basket of goods and services typically consumed by households.
How is the CPI basket created?
ONS Expenditure Survey collects data from households on:
What they buy
How much they pay
Quantity purchased
Where they buy from
% of income spent on each item
What does the CPI basket represent?
It reflects the average household’s spending habits over a fortnight, capturing typical goods/services consumed.
Why are weights used in the CPI?
Items are weighted based on their proportion of household income spent.
E.g., If 10% of income is spent on fuel, fuel gets a 0.1 weight in the index.
Why is weighting important in CPI?
Because price changes in items with higher weights have more impact on the overall inflation figure.
What are the stages of CPI calculation?
Create the weighted basket
Monitor price changes monthly
Multiply price changes by weights
Combine to calculate inflation rate as a % change year-on-year
Why are weights used in the CPI calculation?
To ensure that items we spend more money on have a larger impact on the inflation rate.
How is the CPI calculated from the basket?
Weighted prices of all goods/services are calculated
These are added to find a total weighted price
Converted into index numbers using a base year (value = 100)
What is the base year in CPI, and what value is assigned to it?
The base year is the reference year for comparison; it is always given an index number of 100.
How is an inflation rate calculated using index numbers?
Inflationrate= Index(newyear)−Index(baseyear) ×100
Index(baseyear)
Why is the CPI basket updated every year?
To reflect changes in consumer habits, new goods/services, and spending patterns.
What is the RPI and how does it differ from CPI?
RPI = Retail Price Index
Includes housing costs (e.g., mortgage interest), unlike CPI
Uses a different formula (arithmetic mean vs. geometric in CPI)
Why is CPI preferred over RPI for official inflation targets?
CPI is more internationally standardized, excludes housing costs for comparability, and uses a geometric mean, which is less likely to overstate inflation.
What mathematical method does the RPI use?
The arithmetic mean, which tends to overstate inflation compared to CPI.
What mathematical method does the CPI use?
The geometric mean, which generally gives a lower inflation figure and is preferred by most international standards.
Why does RPI usually show a higher inflation rate than CPI?
Because it uses the arithmetic mean and includes housing costs, both of which push up the figure.
Why might CPI not reflect personal inflation rates?
It measures the inflation of an “average family,” but different households buy different goods. For example, low-income families may not be affected by rising prices in luxury items like foreign holidays.
What is Core CPI?
A version of CPI that excludes volatile items like food and energy prices to give a more stable measure of underlying inflation trends.
Why are items like food and energy excluded from Core CPI?
Their prices are highly volatile due to inelastic demand and supply (e.g., global oil prices), which can distort overall inflation trends.
What is the Producer Price Index (PPI)?
An inflation measure that tracks the prices of inputs for producers, often used as a leading indicator of future CPI inflation.
What is Core CPI?
It’s the CPI excluding volatile items like food, energy, alcohol, and tobacco, giving a better measure of underlying inflation.
What is the purpose of Core CPI?
To identify the underlying trend in inflation, not distorted by short-term price shocks.
What is the Producer Price Index (PPI)?
PPI measures changes in prices of goods as they leave the factory (input prices), often signaling future CPI inflation.
