Consumer Price Index Formula

Consumer Price Index Formula (Table of Contents)

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• Examples
• Calculator

What is the Consumer Price Index Formula?

The term “consumer price index” or CPI refers to the weighted average price of a basket that comprises of commonly used goods and services in any given year period vis-à-vis a base year. Conversely, the consumer price index enables easy comparison of the price changes in the value of the market basket in any period relative to a base year. The formula for the consumer price index can be derived by dividing the value of the market basket in any given year by the value of the market basket in the base year and then multiply the result by 100. Mathematically, Consumer Price Index Formula is represented as,

Examples of Consumer Price Index Formula (With Excel Template)

Let’s take an example to understand the calculation of the Consumer Price Index in a better manner.

Consumer Price Index Formula– Example #1

Let us take the example in which the market basket is comprised of some of the most commonly used items – food, fuel, cloth, and education. As per the recent survey, average consumers spend 35% of their total annual consumption budget on food, 15% on fuel, 25% on clothes and 25% on education. Prepare the consumer price index for the year 2019 if the base year is 2015 and the consumer spending preference remains the same. The following information pertaining to prices are available.

Solution:

Value of Market Basket in the Base Year (2015) is Calculated as

• Value of Market Basket in the Base Year (2015) = (35% * $45) + (15% * $40) + (25% * $50) + (25% * $35)
• Value of Market Basket in the Base Year (2015) = $43

Value of Market Basket in the Given Year (2019) is Calculated as

• Value of Market Basket in the Given Year (2019) = (35% * $50) + (15% * $41) + (25% * $60) + (25% * $40)
• Value of Market Basket in the Given Year (2019) = $48.65

Consumer Price Index is calculated using the formula given below

Consumer Price Index = (Value of Market Basket in the Given Year / Value of Market Basket in the Base Year) * 100

• Consumer Price Index = ($48.65 / $43.00) * 100
• Consumer Price Index = 113.14

Therefore, the Consumer Price Index for the year 2019 stood at 113.14, which means the average price increased by 13.14% during the last four years.

Consumer Price Index Formula– Example #2

Let us take another example where consumer spending is provided in terms of units consumed monthly. The market basket comprises the same four components – food, fuel, cloth, and education. Prepare the consumer price index for the year 2019 if the base year is 2018 and the following information pertaining to prices and consumption are available:

Solution:

Value of Market Basket in the Base Year (2018) is Calculated as

• Value of Market Basket in the Base Year (2018) = (35 * $38) + (20 * $41) + (25 * $30) + (30 * $34)
• Value of Market Basket in the Base Year (2018) = $3,920

Value of Market Basket in the Given Year (2019) is Calculated as

• Value of Market Basket in the Given Year (2019) = (35 * $40) + (20 * $37) + (25 * $35) + (30 * $38)
• Value of Market Basket in the Given Year (2019) = $4,155

Consumer Price Index is calculated using the formula given below

Consumer Price Index = (Value of Market Basket in the Given Year / Value of Market Basket in the Base Year) * 100

• Consumer Price Index = ($4,155 / $3,920) * 100
• Consumer Price Index = 105.99

Therefore, the Consumer Price Index for the year 2019 stood at 105.99, which means the average price increased by 5.99% during the last four years.

Explanation

The formula for the consumer price index can be calculated by using the following steps:

Step 1: Firstly, select the commonly used goods and services to be included in the market basket. The market basket is crated based on surveys, and it should be reflective of the day-to-day consumption expenses of the majority of consumers.

Step 2: Next, identify and fix the base year based on various social and economic factors.

Step 3: Next, determine the value of the market basket based on the weighted average price of the goods and services in the base year.

Step 4: Next, determine the value of the market basket based on the weighted average price of the goods and services in the given year.

Step 5: Finally, the formula for consumer price index can be calculated by dividing the value of the market basket in any given year (step 4) by the value of the market basket in the base year (step 3) and then multiply the result by 100 as shown below.

Consumer Price Index = (Value of Market Basket in the Given Year / Value of Market Basket in the Base Year) * 100

Relevance and Use of Consumer Price Index Formula

The concept of the consumer price index is very important because it is an economic indicator that is usually used as a measure of inflation in the economy or the purchasing power of the consumer. As such, the government and the policymakers use the changes in the consumer price index as a cue to make suitable economic decisions.

However, one of the biggest flaws in the consumer price index is its failure to include cheaper substitutes in the market basket. For instance, when the price of a certain good increase, there is a high possibility that the consumer will substitute the good with a cheaper option, but the consumer price index doesn’t include the cheaper good in its market basket and as such, the index fails to reflect the correct picture in this case.

Consumer Price Index Formula Calculator

You can use the following Consumer Price Index Formula Calculator

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