Glossary

CPI

The Consumer Price Index tracks the price of a fixed shopping basket of everyday things a typical household buys, so we can see how the cost of living changes over time. Picture the same cart every month — rent, groceries, gas, a movie ticket, a phone plan — and compare what it costs now with what it cost in a chosen starting year. If the cart costs more, the CPI has risen.

More precisely, the CPI is a price index measuring the average change over time in the prices households pay for a fixed basket of goods and services. It is set equal to 100 in a base year, so a CPI of 110 means prices are 10 percent higher than in that base year. The inflation rate most people quote is simply the percentage change in the CPI from one year to the next. Because the basket is held fixed, the CPI has a known weakness called substitution bias: when one good gets more expensive, shoppers switch to cheaper alternatives, but the fixed basket keeps assuming they buy the pricier item — so the CPI can slightly overstate the true rise in the cost of living.

\text{CPI} = \frac{\text{Cost of basket in current year}}{\text{Cost of basket in base year}} \times 100

Consumer Price Index

Price the same fixed basket in the current year and in the base year, take the ratio, and multiply by 100. By construction the base-year CPI equals 100, so any value above 100 measures how much prices have risen since then.

Price index: A number that tracks the average price of a set of goods relative to a base year (set to 100). The CPI is the best-known example.
Base year: The reference year against which prices are compared. The CPI equals 100 in the base year by definition.
Substitution bias: The tendency of a fixed-basket index to overstate inflation because it ignores that consumers switch away from goods whose prices rise.
Inflation rate: The percentage change in the CPI between two periods, $\pi = \frac{\text{CPI}_t - \text{CPI}_{t-1}}{\text{CPI}_{t-1}} \times 100$ . See inflation.