Consumer Price Index: Measuring Inflation and Economic Trends

The Consumer Price Index (CPI) is an essential indicator used by economists to evaluate retail inflation within any country’s economy by observing the price instabilities of daily use of common goods and services. It calculates the price shifts of a daily collection of commodities used by consumers, also known as a market basket. This index is instrumental in defining the price variations of fixed items.

Consumer Price Index helps in following the changes in price levels of goods and services that consumers regularly purchase and hence it reflects the demand side of the economy. CPI functions as a significant indicator of the purchasing power of the currency, providing a useful understanding of economic health and consumer behaviour.

What do you understand by Consumer Price Index or CPI

• The Consumer Price Index (CPI) determines the average changes in prices that consumers spend over time for a daily basis selection of goods and services. It fits as a key indicator of inflation, defining how rising costs result in consumers’ everyday expenses and its impact on the economy. The CPI contains all the commodities bought for personal use by the target population.
• The Bureau of Labor Statistics (BLS) has grouped all the basic items in the market basket to measure CPI which is divided into 200 subgroups and further grouped into eight categories that contain foods & beverages, living conditions, transport, clothes, personal care, entertainment, education, communication, and other items.
• CPI is a macroeconomic index used by the state and central governments for evaluating the levels of inflation and making policies. This key monetary tool is closely practised by the Reserve Bank of India to maintain price stability and the efficient functioning of the money flow in the country.

Note: CPI contains taxation that is directly associated with prices of some goods and services including excise and sales tax. However, it does not take into consideration such taxes as income or Social Security taxes as these have nothing to do with the consumers’ purchases. The CPI excludes investment-related assets like stocks, bonds, real estate, as well as life insurance. Consumer Price Index solely relies on the fundamental products that impact everyday life.

What does the Consumer Price Index measure?

• The cost of living
• The purchasing capacity of the population
• The prices of everyday items and services
• The value of the Indian rupee in the international market

How does the consumer price index work?

CPI in layman’s terms stands for consumer price index, which calculates how prices change over time within a list of goods and services that consumers purchase. It helps to understand when common-use products are becoming cheaper or more expensive as compared to the preceding months or years.

To calculate the CPI, a so-called “market basket” of items is used. This basket includes daily use items such as food, clothing, health and transport which are generally consumed. The prices of these items are monitored over time in this way:

• CPI is developed in such a way that when the general price levels increase, CPI also increases, which shows inflation.
• If the general price level decreases, the CPI reduces which indicates deflation.

The increasing level of CPI signifies that the cost of living has gone up, compelling people to spend more money to manage their daily lifestyles.

Applications of the Consumer Price Index (CPI)

1. To understand inflation: The Consumer Price Index is an accurate method to measure inflation than the Wholesale Price Index because it calculates the prices that people pay, instead of wholesale prices.
2. Assessing purchasing power: The CPI shows the position of the currency in the international market in terms of its purchasing value.
3. Checking living conditions: Relative to this the Consumer Price Index checks on the changes in living standards and is therefore vital in policy making.
4. Creating policies: CPI also assists the central government in implementing all policies concerning taxes, prices, exports and imports.
5. Pay allowances: With the help of the CPI, the wage workers are entitled to allowances and other benefits.
6. Adjusting data: CPI is used to calculate salaries, living costs, and the nation’s income.
7. Economic measure: CPI functions as an economic instrument to calculate various monetary facilities along with the price of commodities.
8. Monetary strategy: The Consumer Price Index database is very helpful as well as crucial for the Reserve Bank of India which uses these statistics to adjust its monetary strategy and supervise the inflow of money in the market.

How to measure the Consumer Price Index 

To calculate the Consumer Price Index (CPI), you can use the following formula:

• CPI = (Cost of a Fixed Basket of Goods and Services in the Current Year/cost of a Fixed Basket of Goods and Services in the Base Year) x 100%

Following are the steps to calculate the CPI:

• Make a list of prices of goods and services that were included in the base year and make a similar list in the current year.
• Sum the prices for the current year along with the base year.
• Divide the current year’s total by the base year’s total.
• Multiply the digit by 100.
• The last step is to convert the result into percentage.

Note: The Consumer Price Index base year in India was provided as 2014, which is revised to be replaced in January 2026. The current base year we are using is 2012. It refers to the year from which data of the current year and future years can be compared to different economic variables and indicators.

Drawbacks of the Consumer Price Index 

• The Consumer Price Index only estimates the urban adult population and neglects the rural inhabitants.
• CPI does not include all the necessary factors that concern living standards when estimating the cost of living.
• The major drawback of CPI is that it can be different for different areas and the comparisons can be misleading. A higher index value in one area does not mean that the cost of living is higher there.
• The CPI method is only used on goods and services but does not incorporate the health sector which takes the largest proportion of the economy.

Conclusion

CPI is an inflation measure regarding the changes in the price of goods and services over time. It has a major impact on economic policy which influences the interest rates, wages, and social upliftment programs. CPI has its limitations, it does not capture all the changes in people’s expenditure patterns and the impact of novelties in technology and products. Understanding CPI enables most consumers, firms, and policymakers to make the right decisions within an evolving economy. Because inflation and other global factors have not yet shown signs of fading, a robust CPI structure gives good insight into the economic health of the nation’s economy and helps in addressing plans for maintaining stability and growth.

• Author: Religare Broking
• Last Updated: March 4, 2025