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Consumer Price Index: CNBC Explains

Many Americans check their receipts after going to the grocery store to make sure they've bought everything they need, and perhaps to see if what they paid this time is any different from the last trip.

The U.S. government likes to do the same for the whole country with the Consumer Price Index.

What is this economic measuring tool and why does it matter? Here are the details.

What is CPI?

The Consumer Price Index (CPI) is a "measure of the average change over time in the prices paid by consumers for a market basket of consumer goods and services."

In other words, it indicates the cost of living for a typical consumer, but it's not a straight measurement of living costs, as we'll see later.

What CPI can specifically identify is periods of inflation or deflation for consumers in their day-to-day living expenses.

If there's inflation—when goods and services costs more—the CPI will rise over a short period of time, say six to eight months.

If the CPI declines, that means there's deflation, or a steady decrease in the prices of goods and services.

The CPI is compiled and released every month by the Bureau of Labor Statistics (BLS), which is a sub-agency of the Department of Labor.

What is the CPI used for?

Because the CPI indicates prices changes—both up and down—for the average consumer, the index is used as a way to adjust income payments for certain groups of people.

For instance, more than 2 million U.S. workers are covered by collective bargaining agreements, which tie wages to the CPI. If the CPI goes up, so do their wages.

The CPI also affects many of those on Social Security—47.8 million Social Security beneficiaries receive adjusted increases in income tied to the CPI. Also, millions of military and Federal Civil Service retirees and survivors have benefits tied to the CPI, as do about 22 million food stamp recipients.

Changes in the CPI also affect the cost of lunches for the 27 million children who eat lunch at school. Some private firms and individuals use the CPI to keep rents, royalties, alimony payments, and child support payments in line with changing prices.

Since 1985, the CPI has been used to adjust the federal income tax code to prevent inflation-induced increases in taxes.

What type of information is collected for CPI?

The government wants to know what Americans are buying and how much they're paying.

To find out what people buy most often, the Bureau of Labor Statistics surveys families and individuals. Each year, some 7,000 families from around the country provide information on their spending habits on a quarterly basis.

Another 7,000 families in each of these years keep diaries listing everything they bought during a two-week period.

What part of the population is measured by CPI?

Not all Americans are included in the CPI. Instead, CPI measures the spending patterns for two population groups: all urban consumers, and urban wage earners and clerical workers.

The all urban consumer group represents about 87 percent of the total U.S. population, according to the BLS, which releases the monthly report. Among those studied are professionals, the self-employed, the poor, the unemployed, and retired people, as well as city wage earners and clerical workers.

Excluded from the CPI are the spending patterns of people living in rural areas, farm families, as well as people in the Armed Forces, and those in prisons and psychiatric hospitals.

The fact that the CPI ignores the areas mentioned above has lead many analysts to say the CPI figures do not reflect a true measurementof price increases or decreases.

What goods and services are included in CPI?

The CPI measures costs in these areas, according to the BLS:

  • Food and Beverages (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)
  • Housing (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)
  • Clothes (men's shirts and sweaters, women's dresses, jewelry)
  • Transportation (new vehicles, airline fares, gasoline, motor vehicle insurance)
  • Medical Care (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services)
  • Recreation (televisions, toys, pets and pet products, sports equipment, admissions)
  • Education and Communication (college tuition, postage, telephone services, computer software and accessories)
  • Other Goods and Services (tobacco and smoking products, haircuts and other personal services, funeral expenses)

Also included within the major groups listed above are various government-charged user fees, such as water and sewerage charges, auto registration fees, and vehicle tolls. Also, the CPI includes sales and excise taxes associated with purchases.

However, the CPI excludes taxes—such as income and Social Security taxes—which are not directly associated with the purchase of consumer goods and services.

There's one more item off the list. The CPI does not include investment vehicles, such as stocks, bonds, real estate, and life insurance.

To get all the information it does want, the BLS sends out hundreds of researchers to thousands of retail stores, service establishments, rental units, and doctors' offices, all over the U.S.

What cities have their information released?

The CPI is released monthly for the following urban areas:

  • Chicago-Gary-Kenosha, IL-IN-WI
  • Los Angeles-Riverside-Orange County, CA
  • New York-Northern NJ-Long Island, NY-NJ-CT-PA

Data for the following additional 11 metropolitan areas is published every other month on an odd or even month schedule for the following areas:

  • Atlanta (even)
  • Boston-Brockton-Nashua, MA-NH-ME-CT (odd)
  • Cleveland-Akron, OH (odd)
  • Dallas-Fort Worth, TX (odd)
  • Detroit-Ann Arbor-Flint, MI (even)
  • Houston-Galveston-Brazoria, TX (even)
  • Miami-Fort Lauderdale, FL (even)
  • Philadelphia-Wilmington-Atlantic City, PA-NJ-DE-MD (even)
  • San Francisco-Oakland-San Jose, CA (even)
  • Seattle-Tacoma-Bremerton, WA (even)
  • Washington-Baltimore, DC-MD-VA-WV (odd)

Why isn't the CPI a true cost-of-living index?

A cost-of-living index would measure changes over time in the amount that consumers need to spend to reach a certain standard of living, according to the BLS.

Those standards of living would include changes in governmental or environmental factors that affect consumers' well-being—such as safety and education, health, water quality, and crime.

The CPI does not measure any of those items—and there is currently no official government survey that does. The CPI is as close as it gets.

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