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The Consumer Price Index
CPI Questions and Answers
CPI Questions and Answers
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The Consumer Price Index – October 2001

What is the Consumer Price Index?
Why is the CPI Important?
How is the Basket Created?
How are the Weights Determined?
How are Prices Collected for the CPI?

How is the CPI calculated?
How is the CPI interpreted?
Why Update the CPI?
Why a Harmonised Consumer Price Index?

1. What is the Consumer Price Index?
The Consumer Price Index (CPI) is a measure of the average change in the prices paid by consumers for a specific basket of goods and services over time. This “shopping basket” represents a mix of consumer goods and services purchased by the average household. The importance (or weight) of each item in the “basket” is determined by the amount spent on them by households.

2. Why is the CPI Important?
The CPI is important because many of its applications affect most persons in some way. The CPI is used by employers and other agencies for the adjustment of wages and salaries; by labour unions in collective bargaining; by economists as a guage for assessing the current performance of the economy; as a measure of inflation and by government in formulating and evaluating many economic policies.  top ^

3. How is the Basket Created?
The items in the “basket” are determined from information obtained from Household Income and Expenditure surveys conducted by the Central Statistical Office. During a specified period, a predetermined number of households from around the country provide information on their spending habits by maintaining a diary of everything bought during that specific period.  top ^

This information is used to update the “basket” on which the CPI is based. This update allows for new goods and services that have become significant in households’ budgets, like Internet Service, to be included in the “basket”, and other items which have lost importance to be excluded or have their weights reduced.  top ^

Once the “basket” is set up, the quality and quantity of the items in the basket are kept constant. However, the total cost of this “fixed basket” will vary from one period of time to another, as the prices of the items in the “basket” change. Price changes resulting from such a “constant or fixed basket” are defined as “pure price” movements, which is what the CPI, in essence, measures. The “All Items” index therefore gives in a single figure the percentage change in the cost of purchasing the contents of the “basket” over a period of time.  top ^

4. How are the Weights Determined?
The amount spent on each item in the CPI “basket” is compared to total household spending to obtain the relative importance or “weight” of the commodities in the “basket”. The major categories of the CPI each have representative “group weights”. These weights establish the impact that a particular price change within each category will have on the overall index. For example, a 5 percent rise in the price of cooking gas would have a much greater impact on the household budget than a 5 percent increase in the price of newspapers. This is due to the fact that households spend more on cooking gas than they do on newspapers. Table 1 shows the various weights applied to the categories for each of the eight member countries of the Eastern Caribbean Currency Union.
Table 1
Click to view larger version   top ^

5. How are Prices Collected for the CPI?
The CPI is designed to measure price changes for a fixed basket of goods and services. Price movements must be monitored in several retail outlets from which households do their shopping and also from various business organisations which provide services to households. Monthly prices are collected from outlets such as supermarkets, shoe stores, doctors and beauty parlours. Additionally, price data for bus, ferry and taxi fares, telephone and electricity charges, education and hospital charges are collected from the appropriate authorities.   top ^

6. How is the CPI calculated?
Once the prices of goods and services have been collected, they are scrutinised to ensure validity of the data. Prices are compared with the previous month’s data in order to monitor price fluctuations and maintain consistency from month to month. The prices are also compared to the price in the base period, which in this instance is January 2001 for all countries except Anguilla, which uses December 2000.

The following steps are used by the Statistical Office in calculating the Consumer Price Index:

Step 1: Collect the prices for the items that make up each category in Table I.

Step 2: Calculate the price relative to determine whether the price has increased or decreased relative to the previous month. (Divide the current month’s average price by the previous month’s average price).

Step 3: Derive the current month’s cost. (Multiply the price relative by the previous month’s cost for the specific items )

Step 4: Derive the price index for each category. (Divide the current month’s cost derived in Step 3 by the base period’s (January 2001) cost and multiply by 100.

What this means is that in March 2001 it costs $104.75 to buy the same quantity of bakery products that costs $100.00 in January 2001.  top ^

Step 5: Compute all the items in each sub-index in the same manner (Steps 1 through 4) and then sum and average all items under each sub-index to obtain an aggregate index for that sub-index. For example, under the sub-index “food”, the indices for bakery products, fish, fresh meat etc, are summed and averaged to obtain an aggregate index for the sub-index “food”.  top ^

Step 6: Weigh each sub-index according to the weight assigned for each of the eleven sub-indexes. This represents all goods and services in the “basket” as the “All Items” index and provides the basis upon which inflation can be measured.
Table 2
Click to view larger version  top ^


7. How is the CPI interpreted?
An index is a tool that simplifies the measurement of movements in a series of numbers. The index for the reference period for the CPI is set to 100 and changes in prices are measured in relation to this figure. An index of 104.75, using the index for bakery products as an example, means there has been a 4.75 per cent increase in price since the reference period January 2001. Similarly, an index of say, 90 means a 10 percent decrease since the reference period.

Changes between the “All Items” index for comparative periods will give the inflation rate for that period. For example if the “All Items” index is 156.5 and 167.5 for June 2001 and July 2001 respectively, then the inflation rate at July 2001 is 7.03%

  top ^
8. Why Update the CPI?
As long as there are significant changes in consumer buying habits, introduction of new goods and services (computers and internet) or shifts in the population distribution and composition (immigrants with varying cultures), then a change in the CPI is needed. Table III below shows the various base periods that were previously used by the countries.
Table 3

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9. Why a Harmonised Consumer Price Index?
Since the member countries of the Eastern Caribbean Currency Union (ECCU) use the same currency, it is also necessary to have the ability to compute an Index that represents all of them collectively and this can only effectively be done if they all use a similar base period. Further, as the member countries of the OECS move towards a common market, close monitoring of the inflation rate of the ECCU will become necessary.  top ^

It is important to understand that the market baskets and pricing procedures used for the CPI in member countries represent the experience of the 'average' household, not of any specific family or individual.



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