Consumer Price Index Q8

Thomas Sim PEA2066

Q.
Explain the following terms:

d) Consumer Price Index (4 marks)

(4 marks, 2011 Q8)

What is consumer price index (CPI), and what are the purposes of having CPI?

A.
A consumer price index (CPI) measures changes in the price level of a market basket of consumer goods and services purchased by households.

Calculating the CPI for a single item

Current item price ($) = (base year price) * (Current CPI) / (Base year CPI)

or
frac{CPI_2}{CPI_1}= frac{Price_2}{Price_1}
Where 1 is usually the comparison year and CPI1 is usually an index of 100.
Alternatively, the CPI can be performed as CPI= frac{text{updated cost}}{text{base period cost}} times 100. The "updated cost" (i.e. the price of an item at a given year, e.g.: the price of bread in 2010) is divided by the initial year (the price of bread in 1970), then multiplied by one hundred.[2]

Calculating the CPI for multiple items

Many but not all price indices are weighted averages using weights that sum to 1 or 100.
Example: The prices of 95,000 items from 22,000 stores, and 35,000 rental units are added together and averaged. They are weighted this way: Housing: 41.4%, Food and Beverage: 17.4%, Transport: 17.0%, Medical Care: 6.9%, Other: 6.9%, Apparel: 6.0%, Entertainment: 4.4%. Taxes (43%) are not included in CPI computation.[3]
CPI = sum_{i=1}^{n} CPI_i*weight_i

where the weight_is sum to 1 or 100.

What is its purpose?

CPI provides a comparison on the price of goods and services with reference to a historical moment where the index is 100. It is able to reflect inflation as prices of goods and services increase over time. And, it also provides a calculation on real income as the purchasing power of the income is compared to the prices of goods and services at the moment.

For example, if an income is earned over a period of inflation, the real income may be in fact diminished to purchase the similar amount of goods and services it once able to purchase due to higher CPI.

For example, the Statistics Canada lists out the uses of CPI as:

The Consumer Price Index (CPI) is an indicator of changes in consumer prices experienced by Canadians. It is obtained by comparing, over time, the cost of a fixed basket of goods and services purchased by consumers. Since the basket contains goods and services of unchanging or equivalent quantity and quality, the index reflects only pure price change.

The CPI is widely used as an indicator of the change in the general level of consumer prices or the rate of inflation. Since the purchasing power of money is affected by changes in prices, the CPI is useful to virtually all Canadians. Consumers can compare movements in the CPI to changes in their personal income to monitor and evaluate changes in their financial situation.

The CPI also has a number of specific applications:

(1) It is used to escalate a given dollar value, over time, to preserve the purchasing power of that value. Thus, the CPI is widely used to adjust contracted payments, such as wages, rents, leases and child or spousal support allowances. Private and public pension programs (Old Age Security and the Canada Pension Plan), personal income tax deductions, and some government social payments are also escalated using the CPI.

(2) It is used as a deflator of various economic aggregates, either of income flows, to obtain constant dollar estimates of income, or of expenditure flows, to obtain personal expenditure estimates at constant prices.

(3) It is used to set and monitor the implementation of economic policy. The Bank of Canada, for example, uses the CPI, and special aggregates of the CPI, to monitor its monetary policies.

(4) Business analysts and economists use the CPI for economic analysis and research on various issues, such as the causes and effects of inflation, and understanding regional disparities in price movements. 

Malaysian CPI extracted from Department of Statistics is shown below:

Consumer Price Index Malaysia April 2014 (Updated: 21/5/2014)
The Consumer Price Index (CPI) for the period January to April 2014 increased by 3.5 per cent to 109.8 compared with that of 106.1 in the same period last year. Compared with the same month in 2013, the CPI for April 2014 registered an increase of 3.4 per cent from 106.3 to 109.9 and when compared with the previous month, the CPI remained unchanged at 109.9.

The index for Food & Non-Alcoholic Beverages and Non-Food for the month of April 2014 showed increases of 3.6 and 3.3 per cent respectively as compared to the same month in 2013. For the period January to April 2014, the index for Food & Non-Alcoholic Beverages and Non-Food increased by 3.9 and 3.3 per cent respectively. When compared with the previous month, the index for Non-Food remained unchanged at 107.9 while the index for Food & Non-Alcoholic Beverages decreased by 0.1 per cent.