How the Consumer Price Index (CPI) directly affects you

Marshall Rathmell |
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Author - Harold Sasnowitz

How is the Consumer Price Index (CPI) Calculated

I’ve often wondered how the CPI is calculated.  I know that the Bureau of Labor Statistics (BLS) determines the cost of a representative family’s purchases for the month, each month.  I was wondering what the weight of each of the elements of cost are, so I could get a sense of what the monthly announcements could mean to me.

At the BLS website I found the following weightings:

Food and Beverages                                       15.7%

Housing                                                                40.9%

Apparel                                                                4.4%

Transportation                                                  17.1%

Medical expenses                                            5.8%

Recreation                                                          6.0%

Education and Communications                5.8%

Other Goods and Services                            4.3%

                                Total                                                      100.0%

 

This is important to know so that we don’t get upset when a high CPI change is reported if we’re not affected by the larger weighted elements of the CPI.  For example, if you have a lease or a mortgage, especially a long-term lease or mortgage, that expense will not change, and that is part of the Housing element, and that element is 40.9% of the calculation.  Of course, property tax is also part of that element and that is not a fixed cost in any way.

Food and Beverages contribute 15.7% of the calculation.  I would think that, for most of us, we have  some, but only a little, control over our expenditures in this area.

From the chart above, you can see Recreation is 6.0% and Apparel is 4.4% of the calculation.  Although a relatively small part of the calculation, these are things that you can control.

On the other hand, we have relatively little control over Medical expenses.

Furthermore, you should be aware that there are several CPIs in use:

  • The most common is the All Urban Consumers (CPI-U), which is the one we hear so much about
  • The Urban Wage Earners and Clerical Workers (CPI-W)
  • The All Urban Consumers (Chained CPI) – this is the one that Social Security COLAs are geared to
  • The Average Price Data.

(By the way, all of these indices are available at the Bureau of Labor Statistics website: bls.gov/cpi/data.htm)

So, you see that the announced change in the CPI does not have to be the decisive increase in your own expenditures.

This weighting changes only once in two years.  And, it doesn’t take into account that substitutions are available for some entities within the elements.  For example, cheaper foods can often be substituted for some that are experiencing high cost increases.  Although the CPI does not reflect these options, there is a measure that does.  It is called the Personal Consumption Expenditure Index, often referred to as the PCE.  The PCE can be lower than the CPI because it reflects the substitution capability that we all have.

Lastly, these indices do not reflect what you should be spending, but rather what an average individual or family does spend – and you are not average!