We've understood how GDP works and how it falls short when judging the standard of living among ordinary people. The main reason is that GDP is an all-encompassing indicator and thus loses out on the nuances required to pinpoint a particular trend.
So, let's introduce a new indicator, the Consumer Price Index or CPI, designed to monitor inflation, a major factor affecting people's lives and government policies.
Let's first give a gist of inflation to better understand why these indicators are designed the way they are. Inflation is the rate at which a currency depreciates; this can be thought of as a decrease in purchasing power or, more interestingly, an increase in the supply of currency. Some theories view inflation as a hidden tax and a disease for society, which begs the question of why it exists and who benefits from it. These are questions that we'll tackle in the next couple of blogs.
Consumer price index is referred to as that index that is used in calculating the retail inflation in the economy by tracking the changes in prices of most commonly used goods and services. ~ Byjus
Consumer Price Index is a commonly tracked indicator across most countries. A Bureau is usually tasked with conducting a survey and compiling the data to arrive at the CPI. The CPI is the price of a basket of goods deemed necessary for an average citizen. Things like housing, energy, utilities, grocery, etc., are included in the basket. The bureau is also tasked with updating the basket to keep up with consumerism trends.
The CPI baskets are different for different countries. The US, for example, spends more on meat and dairy products (like cheese) than India. So, chances are that India wouldn't include beef in its basket, making it a more accurate description for its people.
Most countries also use another indicator alongside the CPI to better understand what's happening. The Feds in the US, for example, use something known as the Personal Consumption Expenditure Price Index (PCEPI or PCE), the advantage being that it's a slightly different basket that is updated more frequently (every two months as opposed to CPI's two years). Conversely, India uses the Wholesale Price Index (WPI), a basket that includes wholesale transactions, i.e., primary goods like oil, steel, grains, etc.; as such, the basket and prices are different.
CPI = current price of basket/price of basket in base year * 100
As a ratio, CPI is measured in points and not currency.
Some economists also measure what is known as the Core CPI, a basket that excludes volatile goods, namely fuel and food. As always, dwelling on the 'why.'s behind the definition is meaningless. Instead, it is essential to understand how the indicators are designed and their pros and cons, and thus use them accordingly to arrive at opinions on different macroeconomic factors.
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