Price Index

A Price Index is a measure of the average level of prices. So when we see a news on the TV that “Inflation is rising”, they are really reporting the movement of a Price Index. A price index is a weighted average of the price of a basket of goods and services. Which means that when price indexes is calculated , policy makers weight individual prices by the economic importance of each good. In other words , its just like when you buy a household product which has a higher priority than the rest of the other products so does the price index do by taking weighted average by the importance of that product. Now the most important price indexes are :

  • Consumer Price Index (CPI)
  • Producer Price Index (PPI)
  • GDP Deflator

Since we have already discussed GDP deflator in our earlier posts. Let us now describe the Consumer Price Index,

Consumer Price Index (CPI)

The most common and widely used measure of the overall price level is the consumer price index. The consumer Price Index is the measure of the average price paid by the buyers for market basket of consumer goods and Services. Remember Consumer Goods and Services. For example in United States, the government record the prices of around 80,000 goods and services for more than 200 categories. Than the prices are arranged in to the following eight major groups, listed with some example:

  • Foods and Beverages
  • Housing
  • Apparel
  • Transportation
  • Medical Care
  • Recreation
  • Education and Communication
  • Other Goods and Service

Let me add this again that each of the products in these categories and their prices are weight according to their economic Importance. Please go through THIS link to check the formula and biases of Consumer Price Index.