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Ask About the CPI

by Inflated in Indiana | October 28, 2011

Subject :Finances

Dear Toolkit,

How on earth is the annual cost of living increase computed?


Inflated in Indiana

Dear Inflated,

Great question! The textbook definition of 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 goods and services." It's important to keep in mind that the CPI measures rate of change, not levels of prices.

For example, let's say bananas in Cleveland have gone from 30 cents a pound last year up to 55 cents this year, an increase of 25 cents. Bananas in Boise, however, have gone from 60 cents to 90 cents, an increase of 30 cents a pound. Don't be flummoxed by the high cost of bananas in Boise or by the fact that their cost went up a nickel more than Cleveland's. Cleveland's BPI (banana price index) soared way past Boise's because Cleveland bananas cost 83 percent more now than they used to, while Boise's only went up 50 percent.

The CPI, used as a measure of inflation, keeps tabs on purchasing power (as prices increase, the purchasing power of a dollar declines) and is a handy means to adjust Social Security payments as well as cost of living wage (rent, alimony, child support, etc.) payments.

Every month the Bureau of Labor Statistics (BLS) data collectors "gather price information from selected department stores, supermarkets, service stations, doctors' offices, rental units" and so forth. According to the BLS web site, around 80,000 prices are collected in categories including the following:

  • FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals and snacks)
  • HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)
  • APPAREL (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, cable television, 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 these major groups are various government-charged user fees, such as water and sewerage charges, auto registration fees, and vehicle tolls. The CPI also includes taxes (such as sales and excise taxes) that are directly associated with the prices of specific goods and services. However, the CPI excludes taxes (such as income and Social Security taxes) not directly associated with the purchase of consumer goods and services. The CPI does not include investment items, such as stocks and bonds," according to the BLS.

The remainder of the process is, as you would expect from a statistical agency of our government, quite arcane and unintelligible, having to do with "scientifically selected interrelated samples," Census data of every ilk, and computer programs designed to compute and convert weighted data into indexes for every category and geographic location. Seasonal adjustments, fires, floods, droughts and an array of other natural disasters are also figured into the mix.

If you'd liked to stay on top of this measurement, you can sign up to receive the latest CPI figures via monthly email by going to the Bureau of Labor Statistics web site. And if you'd like some of the BLS publications on this topic, write or call:

Office of Prices and Living Conditions
Bureau of Labor Statistics
2 Massachusetts Avenue, NE., Room 3615
Washington, DC, 20212-0001
Telephone (202) 691-7000