Consumer Price Index (CPI): An Introduction

Have you ever wondered why a loaf of bread cost more this month than last year? Or why does the price of gas cylinders seem to fluctuate constantly? The Consumer Price Index (CPI) is your answer. This crucial economic indicator measures the change in prices consumers pay for a basket of goods and services over time, offering a window into the cost of living and the economy's overall health. Let's understand CPI and explore its significance, how it's calculated, and its impact on our everyday lives

Table of Content

• What is the Consumer Price Index?
• Consumer Price Index India
• Components of CPI
• How is the CPI Determined?
• How Does the Government Use CPI Data to Formulate Policies?
• Instances of Policy Changes Based on CPI Data
• Limitations of the CPI

What is the Consumer Price Index?

The Consumer Price Index (CPI) is a critical economic indicator used to measure changes in the prices paid by households for a basket of commonly purchased goods and services. It reflects the average spending patterns of different population groups and is an essential measure of inflation and deflation. The CPI report uses different survey methodologies, price samples, and index weights.

Consumer Price Index India

All India Inflation rates (November 2023 over November 2022), based on General Indices and CFPIs, are as follows:

Source - https://www.mospi.gov.in/sites/default/files/press_release/CPI_PR_12dec23.pdf

Learn the concept of CPI in this interesting video by the Wall Street Journal

Source - WSJ (YouTube)

Components of CPI

How is the CPI Determined?

The Ministry of Statistics and Programme Implementation (MoSPI) determines the CPI market basket in India. The process involves several steps and is carried out through surveys and data collection methods. Here's how the CPI market basket is determined in India:

1. Consumer Expenditure Survey (CES): The foundation of the CPI market basket in India is based on data collected through the Consumer Expenditure Survey (CES). The National Sample Survey Office (NSSO) conducts this survey under the MoSPI. The survey is conducted periodically and collects detailed information on household expenditures and consumption patterns across various states and income groups.
2. Selection of Items and Commodities: A list of items and commodities commonly purchased by households is compiled based on the data collected from the CES. This list includes many goods and services, such as food, housing, clothing, healthcare, transportation, education, and more.
3. Classification into Groups and Subgroups: The selected items are then categorised into groups and subgroups to create a structured classification system. For example, food items are categorised into cereals, pulses, vegetables, fruits, dairy, etc.
4. Weighting: Each group and subgroup are weighted on their expenditure share in the average urban and rural household's budget to reflect the relative importance of each category in household spending.
5. Collection of Price Data: Price collectors are deployed to various locations, including urban and rural areas, to collect price data on a specified list of items from a representative sample of outlets, markets, and service providers. These prices are collected at regular intervals (usually monthly) and recorded for each item's standard quantity and quality.
6. Calculation of the CPI: The CPI is calculated by comparing the current prices of the items in the basket to those in a specified base period. The result is a price index that measures the change in the cost of the basket over time.
7. Publication and Reporting: The MoSPI publishes the CPI data analysis and insights in India. It provides CPI figures for urban and rural areas, states and union territories. This data is made available to the public and is used for various economic, policy, and research purposes.
8. Periodic Review and Updates: The CPI market basket is periodically reviewed and updated to ensure that it represents the changing consumption patterns of the households. This includes adding new items that have become significant in consumption and removing obsolete items.

How Does the Government Use CPI Data to Formulate Policies?

The CPI provides a base for the government to formulate economic policies and assess their effectiveness. By understanding inflation trends and changes in the cost of living, the government can design policies aimed at:

Instances of Policy Changes Based on CPI Data

1. Interest Rate Adjustments by the Reserve Bank of India: The RBI, India's central bank, closely monitors the CPI to determine its monetary policy, particularly the repo rate. When inflation rises above the target range, the RBI increases the repo rate to control the money supply and curb inflation. Conversely, during periods of low inflation, the RBI can lower the repo rate to stimulate economic growth.
2. Social Security and Pension Adjustments: The government uses the CPI to adjust social security and pension benefits to compensate for inflation and maintain beneficiaries' purchasing power.
3. Minimum Wage Adjustments: The government periodically revises minimum wage levels based on the CPI to ensure that workers receive a living wage and their purchasing power is protected against inflation.
4. Food Security Programs: The government uses CPI data to understand food price inflation and allocate resources for food security programs such as the Public Distribution System (PDS) and the National Food Security Act. This ensures that vulnerable populations have access to affordable food even during periods of high inflation.
5. Agricultural Policies: The government analyses CPI data to understand the impact of agricultural production on food prices and formulates policies to improve agricultural productivity and stabilise food prices.

Let us take a look at a real-world example to understand how the government took measures to lower the inflation in the food and beverages segment.

India saw a jump in food costs in 2021, especially for pulses and vegetables. This drove up the CPI, making things more expensive for everyone. In response to the CPI data indicating rising food prices and overall inflation, the Indian government took several measures:

1. Increase in Import Duties: The government increased import duties on certain food items to discourage imports of these items, which could help stabilise domestic prices. The government hoped to lower prices by limiting the amount of imported goods.
2. Release of Buffer Stocks: The government released extra food stored into the market to increase the supply of food grains, help lower prices and prevent inflation.
3. Direct Cash Transfers: The government initiated direct cash transfers to provide immediate relief to low-income households affected by food inflation. This extra money helped families buy what they needed and cope with rising food prices.

This example shows that CPI data is important for making government decisions. When CPI data shows that prices are going up too fast, the government can apply a multidimensional approach to keep prices steady and ensure people can still afford to buy things they need.

Limitations of the CPI

Here are some of the limitations of the CPI that the consumers must be aware of -

• It only captures a fixed basket of goods and services, potentially neglecting new products and changes in consumer preferences.
• Data collection might not fully represent the diverse spending patterns of the entire population.
• Consumers might switch to cheaper alternatives when prices rise, leading to underestimating inflation.
• Measuring quality changes in goods and services can be challenging, impacting accuracy.
• The CPI reflects historical price changes, not necessarily predicting future inflation.
• It may not fully capture the cost of living in rural areas.
• The CPI might need to pay more attention to the actual cost of living due to the difficulty of capturing informal sector spending.

In A Nutshell

The Consumer Price Index is a valuable tool for both consumers and policymakers. Individuals can make informed decisions about their spending and investments by understanding the CPI and its implications. At the same time, policymakers can formulate effective economic policies to manage inflation, promote economic growth, and protect the purchasing power of consumers. As we progress, efforts to improve data collection, enhance transparency, and refine methodologies are crucial to ensure the CPI's continued effectiveness in guiding individuals and policymakers towards a more stable and prosperous future.