AP_Krugman_Textbook

The Consumer Price Index

The most widely used measure of the overall price level in the United States is the

consumer price index(often referred to simply as the CPI), which is intended to

show how the cost of all purchases by a typical urban family has changed over time.

It is calculated by surveying market prices for a market basket that is constructed to

represent the consumption of a typical family of four living in a typical American

city. Rather than having a single base year, the CPI currently has a base period of

1982–1984.

The market basket used to calculate the CPI is far more com-

plex than the three-fruit market basket we described above. In

fact, to calculate the CPI, the Bureau of Labor Statistics sends its

employees out to survey supermarkets, gas stations, hardware

stores, and so on—some 23,000 retail outlets in 87 cities. Every

month it tabulates about 80,000 prices, on everything from ro-

maine lettuce to video rentals. Figure 15.1 shows the weight of

major categories in the consumer price index as of December

2008. For example, motor fuel, mainly gasoline, accounted for
      3% of the CPI in December 2008.
      Figure 15.2 shows how the CPI has changed since measurement
      began in 1913. Since 1940, the CPI has risen steadily, although its
      annual percent increases in recent years have been much smaller
      than those of the 1970s and early 1980s. A logarithmic scale is used
      so that equal percent changes in the CPI appear the same.
      Some economists believe that the consumer price index system-
      atically overstates the actual rate of inflation. Why? Consider two
      families: one in 1985, with an after-tax income of $20,000, and an-
      other in 2010, with an after-tax income of $40,000. According to
      the CPI, prices in 2010 were about twice as high as in 1985, so those two families
      should have about the same standard of living. However, the 2010 family might have a
      higher standard of living for two reasons.
      First, the CPI measures the cost of buying a given market basket. Yet, consumers
      typically alter the mix of goods and services they buy, reducing purchases of products

144 section 3 Measurement of Economic Performance

figure 15.1

The Makeup of the

Consumer Price Index

in 2008

This chart shows the percentage shares

of major types of spending in the CPI as

of December 2008. Housing, food,

transportation, and motor fuel made up

about 76% of the CPI market basket.

Source:Bureau of Labor Statistics.

Housing

43%

Transportation

12%*

*Excludes motor fuel.

Motor fuel

3%

Apparel

4%

Medical care

6%

Recreation

6%

Education and

communication

6%

Other goods

and services

3%

Food and

beverages

16%

Denise Bober

Theconsumer price index,orCPI,
measures the cost of the market basket of a
typical urban American family.