OTHER MAJOR PRICE INDEXESConsumer Price Index The Consumer Price Index (CPI) is probably the most commonly cited index. Itmeasures the price of a representative basket of goods purchased by consumers. The purpose of the CPIis to track the price of a given basket of goods and therefore it utilizes a Laspeyres, fixed weightcalculation.The CPI is calculated monthly by the Bureau of Labor Statistics, which collects a vast amount of pricedata from surveys of all types of selling establishments. The fixed weights reflect the importance of eachgood in the typical consumer’s budget. The market basket is determined from periodic ConsumerExpenditure Surveys, which are used to update the weighting scheme about once a decade.The CPI is widely used to measure price change and is carefully watched. However, in recent years therehas been considerable discussion that implies that the CPI overstates the “true” increase in the cost ofliving. In fact, there have been suggestions that the use of the CPI to index (or make automatic inflationcorrections) to payments like social security pensions be reduced. If the CPI overstates inflation thensocial security payments have been rising too rapidly and that is something that a deficit-ridden budgetcan ill afford. An important reason why the CPI overstates inflation is the treatment of qualityimprovements. Consider an example such as washing machines. Imagine that a manufacturer introducesa new version that is the same size as its predecessor and looks the same as well. The price of the newmodel is $50 or 10 percent higher than the earlier model. On first glance, the statisticians collecting pricedata for the calculation of the CPI will record a price increase of 10 percent. However, a closer lookindicates that some modifications to the motor assembly makes the machine consume less electricitywhich can lead to substantial lifetime savings in energy costs. Furthermore, a re-design of the drum andplastic parts makes this machine less likely to tear clothing. This is clearly a better machine. Now doesthe $50 price increase reflect the costs of a higher quality machine or does it reflect a higher price ofwashing machines? In all likelihood, the increase reflects both and the statistician must determine howmuch of the $50 to attribute to price change and how much to attribute to quality improvements. It isclear now that conservative government statisticians have been systematically underestimating theimportance of quality improvements.
15Another issue that influences the CPI is the way statisticians handle new products. Many new products(computers, calculators, etc.) decline in price for a period of time after their initial introduction. If theindex number calculations are slow to introduce new products, then these periods of often rapid pricedecline are systematically being overlooked. Again, the measured CPI will overstate the inflation rate.