Problem 14 Explain how the CPI is computed.... [FREE SOLUTION]

Chapter 6: Problem 14

Explain how the CPI is computed.

Short Answer

Expert verified

The CPI is calculated by taking price changes for each item in a predetermined basket of goods and averaging them. The goods are weighted according to their importance. The prices are collected on a set of representative goods and services from various sales outlets. The CPI is computed by taking the cost of the basket in the current period, dividing it by the cost of the basket in the base period, and then multiplying by 100.

Step by step solution

Understand the Concept of CPI

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services. This basket can include items like transportation, food, medical care, and other goods and services that people buy for day-to-day living. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance.

Collect Price Information

To calculate the CPI, price information on a set of representative goods and services in the basket has to be gathered. The prices are collected from a sample of sales outlets from various locations.

Calculate the Cost of the Basket

After gathering the information about the prices, the next step is to calculate how much it costs to purchase the basket of goods and services at the base period and the current period.

Compute the CPI

Finally, the CPI is computed by taking the cost of the basket in the current period and dividing it by the cost of the basket in the base period. Then multiply the result by 100 to get the CPI index. The formula used is \( CPI = \frac{Cost\; of\; the\; basket\; in\; the\; current\; period}{Cost\; of\; the\; basket\; in\; the\; base\; period} 脳 100 \). The base period CPI is usually set at 100, and the current period CPI tells us the percentage increase or decrease in cost of living compared to the base period.