Consumer price index (CPI)
CPI - A measure of changes in the price of a representative basket of goods and services. Differs from RPI in methodology and coverage.
- Forms the basis of the inflation target
- Main measure used in the rest of the EU
- Weighted price indice.
In the UK - statisticians employed by the ONS seek to find out what people spend their money on by carrying out the Family Expenditure Survey.
Family Expenditure Survey - involves sampling more than 6,000 households, which are asked to keep a record of their expenditure - as a result, statisicans create a representative sample of about 650 goods and services - products have weights attached to them - weights reflect the proportion of money spent on different items.
Next stage find out how the items have changed in price
Retail Price Index (RPI)
RPI - measure of inflation that is used for adjusting pensions and other benefits to take account of changes in inflation and frequently used in wage negotiations. Differs from CPI in methodology and coverage.
CPI and RPI are calculated using the same underlying price data
RPI, unlike CPI, includes all housing costs including mortgage interest payments, council tax, road fund licence, TV licence.
CPI, unlike RPI, includes uni accomodation fees, foreign student uni tuition fees and stockbrokers' charges.
Differences and similarities between CPI and RPI
- CPI weights are based on spending by all private households, foreign visitors to the UK and residents of institutional households.
- RPI weights are based on expenditure by private households only! Excluding highest income households and pensioner households mainly dependent on state benefits.
- CPI uses a geometric mean in constructing the index
- RPI uses an arithmetic mean.
Difficulties in measuring inflation
To assess whether prices are rising, the prices of the same goods and service should be compared. In practice, though, goods and services change, often improving in quality. Price rise may reflect a higher charge to cover improvements rather than it becoming more expensive. Measures of inflation tend to overstate inflation, as they measure the price of a fixed basket of products. Although the weights are revised each year, the measures do not take into account people’s ability to alter what they buy during the year. People usually move away from buying products that are becoming relatively expensive towards those that are becoming relatively cheaper.