Addendum to Frequently Asked Questions
The CPI is the most widely used measure of inflation
and is sometimes viewed as an indicator of the effectiveness of
government economic policy. It provides information about price changes
in the Nation's economy to government, business, labor, and
private citizens and is used by them as a guide to making economic
decisions. In addition, the President, Congress, and the Federal Reserve
Board use trends in the CPI to aid in formulating fiscal and monetary
The CPI and its components are used to adjust other
economic series for price changes and to translate these series into
inflation-free dollars. Examples of series adjusted by the CPI include
retail sales, hourly and weekly earnings, and components of the National
Income and Product Accounts.
An interesting example is the use
of the CPI as a deflator of the value of the consumer's dollar to find
its purchasing power. The purchasing power of the consumer's dollar
measures the change in the value to the consumer of goods and services
that a dollar will buy at different dates. In other words, as prices
increase, the purchasing power of the consumer's dollar declines.
The CPI is often used to adjust consumers' income
payments (for example, Social Security) to adjust income eligibility
levels for government assistance and to automatically provide
cost-of-living wage adjustments to millions of American workers.
As a result of statutory action the CPI affects the income of millions of Americans.
Over 50 million Social Security beneficiaries, and military and Federal Civil
Service retirees, have cost-of-living adjustments tied to the CPI. In addition, eligibility criteria
for millions of food stamp recipients, and children who eat lunch at school,
are affected by changes in the CPI. Many collective bargaining agreements
also tie wage increases to the CPI.
Another example of how dollar values may be
adjusted is the use of the CPI to adjust the Federal income tax structure. These
adjustments prevent inflation-induced increases in tax rates, an effect called
Traditionally, the CPI was considered an upper bound on a
cost-of-living index in that the CPI did not reflect the changes in buying or
consumption patterns that consumers would make to adjust to relative price
changes. The ability to substitute means that the increase in the cost to
consumers of maintaining their level of well-being tends to be somewhat less
than the increase in the cost of the mix of goods and services they previously
Since January 1999, a geometric mean formula has been used to calculate
most basic indexes within the CPI; in other words, the prices within most
item categories (for example, apples) are averaged with the use of a geometric
mean formula. This improvement moves the CPI closer to a cost-of-living measure,
because the geometric mean formula allows for a modest amount of consumer
substitution as relative prices within item categories change.
It is important to note that area CPIs cannot be used to
compare levels of living costs or prices across areas. (See answer to
Question 18: "Can the CPIs for individual areas be used to compare
living costs among areas?")
For example, if you or your family spends a larger-than-average share
of your budget on medical expenses, and medical care costs are increasing more
rapidly than the cost of other items in the CPI market basket, your personal
rate of inflation may exceed the increase in the CPI. Conversely, if you heat
your home with solar energy, and fuel prices are rising more rapidly than other
items, you may experience less inflation than the general population does. A national
average reflects all the ups and downs of millions of individual price
experiences. It seldom mirrors a particular consumer's experience.
This information enabled BLS to construct the CPI market basket
of goods and services and to assign each item in the market basket a weight,
or importance, based on total family expenditures. The final stage in the
sampling process is the selection of the specific detailed item to be priced
in each outlet. This is done in the field, using a method called
disaggregation. For example, BLS economic assistants may be directed to price
"fresh whole milk." Through the disaggregation process, the economic assistant
selects the specific kind of fresh whole milk that will be priced in the outlet
over time. By this process, each kind of whole milk is assigned a probability
of selection, or weight, based on the amount the store sells. If, for example,
Vitamin D homogenized milk in half-gallon containers makes up 70 percent of the
sales of whole milk, and the same milk in quart containers accounts for 10
percent of all whole-milk sales, then the half-gallon container will be 7 times
as likely to be chosen as the quart container. After probabilities are
assigned, one type, brand, and container size of milk is chosen by an objective
selection process based on the theory of random sampling. The particular kind
of milk that is selected by disaggregation will continue to be priced each
month in the same outlet.
In sum, price changes are weighted by the importance of the item in
the spending patterns of the appropriate population group. The combination of
all these factors gives a weighted measurement of price change for all items in
all outlets, in all areas priced for the CPI.
The following are some examples of technical or statistical
guidelines from BLS:
The following illustration shows that although Area B
has higher prices than Area A, the price change in Area A has been
greater than in Area B.
- For escalation, BLS strongly recommends using indexes that are not seasonally adjusted. (See
answer to Question 15, for a further explanation of seasonally
adjusted indexes and the reasons BLS does not recommend seasonally adjusted
indexes for use in escalation.)
- Also for escalation, BLS recommends using national or regional indexes,
due to the volatility of local indexes. (See answer to Question 16,
for an explanation of this point.)
For those with further questions, BLS has prepared a fact sheet, Using
the Consumer Price Index for Escalation (PDF
12K). This information also may be obtained by writing or calling the nearest BLS regional office listed in the
answer to Question 22. You may also call the BLS national office at (202)691-700.
Base Period Current Period
Price Index Price Index
Area A $0.30 100 0.55 183
Area B 0.60 100 .90 150
The CPI thus measures the rates of change in prices, rather than the level of prices.
CPI Frequently Asked Questions.
Last Modified Date: August 22, 2008