Definition: The Consumer Price Index or (CPI) measure the change in the price level of a basket of consumer goods and services. In other words, consumer price index is a measure that computes a weighted average of the prices of each item included in the commodity basket, such as food, clothing, furniture, drinks, etc.
The basket of goods and services refers to the fixed list of consumer commodities valued and used on an annual basis to determine the rate of inflation in a particular market or country. Often, the contents or the items included in the basket of goods are adjusted periodically corresponding to the changes in the tastes and preferences of the consumers.
The consumer price index is calculated by collecting the price changes in each item of the basket of goods and then averaging them and assigning weights to each item on the basis of its importance. Numerically, the consumer price index is calculated as:
For example, if a consumer buys 3 pairs of jeans, 2 chocolates, and 1 book. In the previous year (base period) the price of a jeans, chocolate and book were Rs 500, 20 and 300 respectively. In the current period, the price of these items changed to Rs 520, 15, and 280 respectively. Then Consumer price index will be calculated as:
Market Basket Price (base period) = 3* (500) + 2* (20) + 1* (300) = 1840
Market Basket Price (current period) = 3* (520) + 2* (15) + 1* (280) = 1870
CPI for multiple items = 1870/1840 * 100 = 101.63