What is a Basket of Goods?
The consumer price index (CPI), commonly used to gauge inflation, assesses the price variations over time for a basket of goods and services. This basket mirrors consumer spending habits, and any change in its price signifies the inflation rate consumers collectively experience.
For example, if the basket’s price has increased by 5% over the course of a year, consumer inflation can be said to be running at a 5% annual rate. The specific definition and contents of this basket can vary widely from one country to another.
In the U.S., the Bureau of Labor Statistics (BLS) collects data on the prices of approximately 94,000 items monthly from a scientifically selected array of goods and services to create this representative basket. Prices are adjusted to negate improvements in product quality and then weighted according to consumer spending patterns derived from an annual survey of about 36,000 consumers.
Key Highlights
- A basket of goods mirrors consumer spending habits and is used to monitor the changes in prices of consumer goods and services over time.
- The Bureau of Labor Statistics monitors 94,000 prices monthly to gauge inflation for over 200 categories of products and services.
- The U.S. CPI basket allocates around 33.3% weight to shelter costs mainly derived from rents and homeowners’ equivalent rent.
- CPI calculations account for consumer substitution of more expensive items with alternatives and adjust for price hikes reflecting product enhancements.
Deconstructing the Basket of Goods
With monthly sampling of 94,000 prices, the BLS employs a vast basket to achieve an accurate measurement of price changes for consumer goods and services across the U.S. economy.
Large categories of consumer spending like food, energy, apparel, and services include extensive subcategories tracking inflation for items such as apples, high-octane gasoline, men’s underwear, and funerals.
These prices are primarily gathered through visits by BLS data collectors to about 23,000 retail and service outlets in 75 urban areas.
Sampling items at each location occurs randomly and with odds proportional to their expenditure share relative to category alternatives in brand, type, and size or weight dimensions. Each product remains in the sample for four years.
Housing rents and owners’ equivalent rent are derived from a survey of 43,000 rental housing units. These constitute the core of the shelter category, which holds a 33.3% weight in the U.S. CPI.
How the Government Calculates CPI
Once gathered, BLS product specialists make necessary adjustments to the prices to ensure the changes are reflective of inflation rather than product improvement costs in items such as vehicles, appliances, and electronics.
These prices contribute to the computation of basic indexes for 211 goods, services, and housing categories across 32 geographic subdivisions of all U.S. urban areas. The BLS then calculates over 7,700 item-area basic indexes, which incorporate the substitution of less expensive items for more costly ones within and among spending categories.
These indexes are weighed based on recent two-year data from an in-depth consumer spending survey to calculate two variations of the consumer price index.
The CPI for All Urban Consumers (CPI-U) reflects the spending habits of approximately 93% of the U.S. population living in areas where the BLS compiles price data. This CPI-U index is primarily used to provide headline numbers about consumer price changes, or the inflation rate.
The CPI for Urban Wage Earners and Clerical Workers (CPI-W) covers roughly 29% of the population, including households primarily earning from clerical or wage-related occupations. The CPI-W is pivotal for adjusting inflation-rate based payments due to Social Security beneficiaries, military and federal civil service retirees, and food stamps recipients. It’s also used to determine adjustments in federal income tax brackets.
Understanding CPI and Its Relation to Inflation
While CPI and inflation are often used interchangeably, CPI specifically measures consumer-experienced inflation. Other metrics gauge different inflation manifestations. The producer price index (PPI) measures price fluctuations paid by producers, whereas the employment cost index assesses labor market inflation. The BLS additionally tracks changes in import and export prices. The gross domestic product price deflator offers an inflation measure encompassing the U.S. economy’s changes in prices, including exports but excluding imports.
Real World Example
The U.S. CPI, particularly the CPI-U for all urban consumers, rose by 1.2% in March 2022 with an 8.5% spike over the preceding 12 months. Gasoline prices surged by more than 18% in March, largely owing to the geopolitical turmoil following Russia’s invasion of Ukraine. Excluding the volatile food and energy costs, the core CPI climbed 0.3% month-over-month and 6.5% annually.
Policymakers strive to control inflation due to its economic impact¸ using the representative basket of goods and services, as gauged by the CPI, to set monetary policy. For instance, the U.S. Federal Reserve aims for a 2% annual inflation, considering it optimal for stable prices and maximum employment.
In a recent move, the Federal Reserve’s Federal Open Market Committee (FOMC) raised the federal funds rate target range to 0.75% to 1% in May, signaling confidence in achieving a 2% inflation rate with appropriate monetary policy adjustments. As per the FOMC’s update, ongoing hikes in the target range might be necessary.
Related Terms: Consumer Price Index, Inflation, Bureau of Labor Statistics, Federal Reserve, Federal Funds Rate.
References
- The World Bank. “Metadata Glossary: Consumer Price Index”.
- U.S. Bureau of Labor Statistics. “Consumer Price Index: Data Sources”.
- U.S. Bureau of Labor Statistics. “Consumer Price Index Frequently Asked Questions”.
- U.S. Bureau of Labor Statistics. “Consumer Price Index News Release”.
- U.S. Bureau of Labor Statistics. “Consumer Price Indexes Overview”.
- American Economic Association. “CPI Housing Survey – BLS Invites Comments”.
- U.S. Bureau of Labor Statistics. “Frequently Asked Questions about Hedonic Quality Adjustment in the CPI”.
- U.S. Bureau of Labor Statistics. “Handbook of Methods, Consumer Price Index: Calculation”.
- U.S. Bureau of Labor Statistics. “Incorporating a Geometric Mean Formula Into the CPI”.
- U.S. Bureau of Labor Statistics. “Frequently Asked Questions about the Chained Consumer Price Index for All Urban Consumers (C-CPI-U)”.
- U.S. Bureau of Labor Statistics. “Overview of BLS Statistics on Inflation and Prices”.
- Bureau of Economic Analysis. “Prices & Inflation”.
- U.S. Bureau of Labor Statistics. “Consumer Price Index – March 2022”.
- Board of Governors of the Federal Reserve System. “Federal Reserve Issues FOMC Statement”.
