Kavan Choksi Sheds Light on the Use of the Consumer Price Index or CPI as a Cost-of-Living Index
The Consumer Price Index (CPI) is a monthly measurement of U.S. prices for household goods and services. Kavan Choksi mentions that the CPI reports inflation and deflation, both of which may hurt a healthy economy. Kavan Choksi mentions that the CPI is the measurement used by economists for the purpose of tracking price changes in a typical “basket” of goods and services purchased by urban consumers. Price changes are monitored by the Federal Reserve to ensure economic growth remains stable. It makes use of monetary policy tools to intervene if it detects too much inflation or deflation.
Kavan Choksi talks about using the Consumer Price Index or CPI as a cost-of-living index
The Bureau of Labor Statistics (BLS) computes the CPI by taking the average weighted cost of a basket of goods in a given month and subsequently dividing it by the weighted cost of the same basket the previous month. It then multiplies the percentage by 100 in order to get the number for the index.
The CPI frequently is called a cost-of-living index. However, it does differ in significant ways from a complete cost-of-living measure. A cost-of-living framework is widely used for making a number of practical decisions in regard to the questions that arise in constructing the CPI. A cost-of-living index is a conceptual measurement goal, and cannot be considered to be a straightforward alternative to the CPI. A cost-of-living index would tend to measure changes over time in the amount that consumers are required to spend to reach a particular standard of living or utility level. Both cost-of-living index and CPI typically reflect changes in the prices of goods and services, like clothing and food that are purchased from the market place directly. However, one needs to remember that a complete cost-of-living index would go beyond this role, Ut shall also take into account the changes in distinctive governmental or environmental factors that impact the well-being of the consumers.
Determining the appropriate treatment of public goods like safety and education, as well as broad concerns such as health, water quality, and crime, to create a comprehensive cost-of-living framework is very challenging. As the CPI does not attempt to quantify all the factors that impact the cost of living, it is at times referred to as a conditional cost-of-living index.
Traditionally, the CPI was seen as an upper limit on a cost-of-living index because it did not account for changes in consumer buying or consumption patterns in response to relative price changes. The capacity for substitution implies that the rise in the cost for consumers to maintain their level of well-being is generally somewhat lower than the increase in the cost of the original mix of goods and services they used to purchase. As Kavan Choksi says, since the January of 1999, a geometric mean formula has been used for calculating the most basic indexes within the CPI. In other words, the prices within most item categories tend to be averaged with the use of a geometric mean formula. This improvement is known to move CPI closer to a cost-of-living measure, as the geometric mean formula facilitates a modest amount of consumer substitution as relative prices within item categories change.
