Price index

A price index is the price of a group of products expressed as a percentage of the price of a comparable group of products at an earlier date. The Consumer Price Index (CPI), which is the most widely-used price index, is the price of the "basket" of products that is purchased by the typical consumer, expressed as a percentage of the price charged for a comparable basket at a stated base date. The CPI is often used as an inflation target by central banks and other monetary authorities. More generally, it provides an indication of changes in the cost of living and is used as as a factor to "index" past payments in order to maintain their purchasing power. Some price indexes can also be used as a divisors, or "deflators", that can be applied to percentage increases of quantities measured in monetary units, such as dollars, in order to estimate their percentages had they been measured in physical units, such as gallons. Price indexes are also available for a variety of other prices including those of factory inputs and outputs, commodities and housing.

Methodology

The construction of price indexes poses issues of which those affecting consumer price indexes are typical. Different countries have adopted different ways of calculating consumer price indexes but they have important features in common. The subject of a consumer price index is the mix of the purchased items that are bought by a typical consumer. The price index is calculated as the weighted average of the current prices of those items expressed as a percentage of the weighted average of their prices in a previous year, termed the reference year. In calculating those averages, the weight applied to each item is an estimate of the share of that item in the total of consumers’ expenditure. The weights adopted can be derived from national accounts or from surveys set up for the purpose. However, since the composition of consumer expenditure is constantly changing, a choice has to be made whether to use weights corresponding to the current mix, or to the mix at a stipulated previous year, termed the base year (which is usually, but not always, the same as the reference year), or to some intermediate mix. Similar issues arise in the construction of other price indexes: for producer price indexes, the choice concerns the weighting of items in the mix of outputs; and for housing price indexes, the weighting of items in the mix of house types.