The Consumer Price Index (CPI) is the Federal government’s measurement of monthly and annual inflation at the retail level. The statistic is created by the Bureau of Labor Statistics using a “secret shopper” survey whereby firms throughout the country are surveyed on the prices of a market basket of goods and services. Much of the methodology is kept secret so that individual firms or industries cannot knowingly influence the inflation index number. Economic theory suggests that price stability is a good thing and that changes in prices should reflect supply and demand factors rather than government policies; however, over the past 100 years, the government has maintained a fairly inflationary policy, meaning that notwithstanding market conditions, prices generally rise over time.
The Bureau of Labor Statistics’ (BLS) projection of CPI for the month of August 2014 was released showing that overall price levels for the month were down by 0.2 percent. This means that inflation for the past 12 months has been running at about 1.7 percent. The Consumer Price Index is based on an ever changing market basket of goods. This means that it takes into account substitution effects – as prices for a product like beef increase, people substitute chicken. This differs from the PPI (reported on above) as adjustments in the market basket occur much more rapidly than changes in production processes.
It is interesting to see the substitution effects and how they impact the CPI. Going back a year to August of 2013, the percentage of the consumer market basket attributed to food was 15.110 percent. By August of 2014, this had fallen substantially to 14.873 percent. On the other hand, the percentage of CPI attributed to medical care rose from 7.114 percent to 7.539 percent. Substitutions are easy to see in the index as well. In 2013, beef accounted for .560 percent of the market basket, and poultry accounted for .351 percent. In 2014, the percentages were .530 and .356 respectively. So beef purchases as a percent of the total were down by 5 percent and poultry purchases were up by 1.4 percent.
The market basket calculation also shows that energy use is way up. In 2013 energy and energy products accounted for 9.729 percent of the market basket. This had increased by about 4 percent in 2014 to 10.118 percent of the overall market basket. Since energy prices (which are set by the world market) have been falling and the share of the market basket has been rising, this alone has helped hold CPI down a lot over the last year. Even so, consumer prices are increasing about as fast as median wages so people are not feeling any better from the low inflation rates.
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