The consumer price index (CPI) is a weighted price index which measures the monthly change
in the prices of goods and services. The spending patterns on which the index is weighted are
revised each year, mainly using information from the Family Expenditure Survey. The
expenditure of some of the higher income households, and of pensioner households mainly
dependent on state pensions, is excluded. As spending patterns change over time, the weightings
used in calculating the CPI are altered.
Calculating a weighted price index
The following hypothetical example shows how to calculate a weighted price index for a number
of categories of consumer spending.
Weights are attached to each category and then we multiply these weights to the price index for
each item of spending for a given year.
The price index for this year is: the sum of (price x weight) / sum of the weights
So the price index for this year is 104.1 (rounding to one decimal place)
The rate of inflation is the % change in the price index from one year to another. So if in one
year the price index is 104.1 and a year later the price index has risen to 112.5, then the annual
rate of inflation = (112.5 – 104.1) divided by 104.1 x 100. Thus the rate of inflation = 8.07%.
Limitations of the Consumer Price Index as a measure of inflation
The retail price index is a thorough indicator of consumer price inflation for the British economy
but there are some weaknesses in its usefulness for some groups of people.
The CPI is not fully representative: Since the CPI represents the expenditure of the
‘average’ household; it may be inaccurate for the ‘non-typical’ household. 14% of the
index is devoted to motoring expenses - inapplicable for non-car owners. Single people
have different spending patterns from households that include children, young from old, male from female, rich from poor and minority groups. We all have our own ‘weighting’
for goods and services that does not coincide with that assigned for the retail price index.
Housing costs: The ‘housing’ category of the CPI records changes in the costs of rents,
mortgage interest, property and insurance, repairs. It accounts for around 16% of the
index. Housing costs vary greatly from person to person, from the young house buyer,
mortgaged to the hilt, to the older householder who may have paid off his or her
Changing quality of goods and services: Although the price of a good or service may rise,
this may be accompanied by an improvement in quality as the good. It is hard to make
price comparisons of, for example, electrical goods over the last 20 years because new
audio-visual equipment is so different from its predecessors. In this respect, the CPI may
over-estimate inflation. The CPI is slow to respond to the emergence of new prod