Consumer Price Index Unit 3 – Lesson 2. CPI- Definition O The Consumer Price Index (CPI) is a measure used by countries to determine the inflation rate.

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Presentation transcript:

Consumer Price Index Unit 3 – Lesson 2

CPI- Definition O The Consumer Price Index (CPI) is a measure used by countries to determine the inflation rate (the general movement in price levels).

Categories O Within the eight categories are over 600 items that an average family of four would consume. O Clothing and footwear; O Alcoholic beverages and tobacco products; O Health care; O Shelter; O Transportation; O Food; O Recreation, education, and reading; O Household operations and furnishings.

Formula O Inflation rate= (CPI year 2 – CPI year 1)/ CPI year 1 x 100 O Year one= the older year O Year two= the most recent year.

Example O In 1995, country X’s overall CPI was 200, and in 1996 it was 211. The inflation rate is calculated as shown in the example below O ( )/200 x100 = 5.5% is the inflation rate for the year.

Answer Country X has a CPI rate of in The same country X has a CPI of in What is the overall inflation rate? 34.47% 2. What is the overall average yearly inflation rate? 3.45%

Limitations of the CPI #1 O An issue of interest regarding the CPI is the weighting of different categories. O The CPI is a statistical model that generalizes its results on all Canadians despite the fact that some Canadians do not spend any money on certain items. O These inconsistencies result in a generalization that works for the ‘’typical’’ urban family, not all the families in Canada. O Thus for example if there were a huge increase in tobacco prices in a given year and you do not consume tobacco, this generalization would not be applicable to you.

Limitations of the CPI #2 O According to Stats Can, the average family consists of four people. O All calculations of the CPI are based on this number. It comes as no surprise to most people that many households do not have 4 members. O Thus these averages are approximations of the annual inflation and not the actual inflation.

Limitations of the CPI #3 O Certain key items are omitted from the calculation of the CPI. O The inclusion of the cost of new automobiles and housing was removed from the CPI in the late 70’s because these items were considered to be inflationary. O This omission is a clear break from the stated purpose of the CPI. The index is a theoretical model, but if important elements are removed because they are too inflationary, this invalidates the use of the CPI.