The Consumer Price Index, or CPI, measures changes in product costs over a specified period of time. Economists use the CPI to track changes in the cost of living, as well as an indicator of economic expansion. The CPI uses the price fluctuations in a pre-determined set of diverse products, including food, fuel, clothing and other consumer goods, to measure changes in the economy as a whole.
Base Year and Product Basket
The CPI measures prices starting from a base year as a means of comparison to current prices. The CPI also uses a "product basket" of various categories to measure price trends across the entire economy, rather than just for a specific industry. These categories and services include food, housing, clothing, transportation and medical care. The price index for each category is the ratio of the category's current price and its price in the base year, multiplied by 100. For instance, if the current price for products in the "food" category is $300, and the price for those same products in the base year was $200, the food category's price index is (300/200)* 100, or 150.
The Simple CPI is the average of the various price indexes for each category. It gives equal weight to each category, regardless of how much consumers spend on products in that category. For example, if the food category has a price index of 150, the transportation category has a price index of 180, and the housing category has a price index of 240, the CPI for those three categories is (150+180+240)/3, or 190.
The Weighted CPI assigns weights to each category depending on its importance. This gives a more accurate description of prices across the economy, as it places more emphasis on categories in which consumers spend more. Consumer spending data determines the weights assigned to each category. Using the example above, consumer spending data may show that consumers spend a specific amount on transportation, double that amount on housing and triple that amount on food. The weighted CPI would be [(3_150) + (2_180) + (1*240)]/3, or 350.
CPI-U vs. CPI-W
The Urban CPI, or CPI-U, is based on the spending habits of nearly all residents of major metropolitan areas, including wage earners, clerical workers, professionals, freelance workers, the unemployed, retired workers, and those living in poverty. The CPI for Urban Wage Earners and Clerical Workers, or CPI-W, functions as a subset of the CPI-U. Households measured in the CPI-W must have earned at least half their income from clerical or hourly wage jobs and at least one household member must have been employed for at least 37 weeks in the previous 12 months. The CPI-W represents the CPI for those currently employed, while the CPI-U covers both working and non-working segments of the population.