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Addendum to Frequently Asked Questions
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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 policies.
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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.
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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
bracket creep.
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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 purchased.
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?")
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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.
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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.
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The following are some examples of technical or statistical
guidelines from BLS:
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For escalation, BLS strongly recommends using indexes that are not
seasonally adjusted. (See answer to Question 16, 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 17, 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). This information
also may be obtained by writing or calling the nearest BLS regional
office listed in the answer to Question 23. You may also call the BLS
national office at (202)691-700. 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. 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.
Last Modified Date: March 2, 2011
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