# What Is the Consumer Price Index (CPI)?

> **Definition**
>
> The Consumer Price Index (CPI) presents the percentage change in prices that consumers pay for goods and services.

## What Is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI), calculated by the Bureau of Labor Statistics (BLS), measures the monthly change in price for a figurative basket of goods and services. These items can change over time.

CPI is a [weighted average](https://www.investopedia.com/terms/w/weightedaverage.asp) of prices and is representative of aggregate U.S. consumer spending. It is used as a metric for inflation and deflation.

The CPI report uses a different survey methodology, price samples, and index weights than the [producer price index (PPI)](https://www.investopedia.com/terms/p/ppi.asp), which measures changes in the prices paid by U.S. producers of goods and services.

### Key Takeaways

*   The composition of the group of goods and services assessed by the Consumer Price Index can change over time.
*   The CPI is a widely used measure of inflation, closely followed by policymakers, financial markets, businesses, and consumers.
*   It's based on about 80,000 price quotes collected every month from retail stores, service establishments, rental units, and doctors' offices.

![Consumer Price Index](https://www.investopedia.com/thmb/5g9Xxpl7vm44HStxowoLbuAb-Ik=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/consumerpriceindex_final-c8acc0dc0a754dc988db4681ca41d99c.png)

*— Investopedia / Katie Kerpel*

## Understanding the CPI

### Data Collection

The BLS collects about 80,000 prices monthly from retail stores, service establishments, rental units, and doctors' offices.

The data compiled and used to track prices covers 93% of the U.S. population. User fees and sales or excise taxes are included in CPI while income taxes and the prices of investments such as stocks, bonds, or life insurance policies are not.

### Data Adjustments

The CPI accounts for [substitution effects](https://www.investopedia.com/terms/s/substitution-effect.asp)—consumers' tendency to shift spending away from products and product categories that have grown relatively more expensive with time.

It also adjusts price data for changes in product quality and features. The weighting of the product and service categories in the CPI indexes corresponds to recent consumer spending patterns derived from a separate survey.

Shelter category prices are based on a survey of rental prices for 50,000 housing units. They are then used to calculate the rise in rental prices as well as owners' equivalents.

The owners' equivalent category models the rent equivalent for owner-occupied housing to properly reflect housing costs' share of [consumer spending](https://www.investopedia.com/terms/c/consumer-spending.asp).

## Types of CPIs

The BLS publishes two CPI indexes each month. The [Consumer Price Index for All Urban Consumers (CPI-U)](https://www.investopedia.com/terms/c/cpiu.asp) represents 93% of the U.S. population not living in remote rural areas.

It doesn't cover spending by people living in farm households, institutions, or on military bases. CPI-U is the basis of the widely reported CPI numbers that matter to financial markets.  
  
The BLS also publishes the [Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W)](https://www.investopedia.com/terms/c/cpi-w.asp). The CPI-W covers 29% of the U.S. population living in households with income derived predominantly from clerical employment or jobs with an hourly wage.

CPI-W is used to adjust Social Security payments as well as other federal benefits and pensions for changes in the cost of living.

It also shifts federal income [tax brackets](https://www.investopedia.com/terms/f/federal_tax_brackets.asp) to ensure taxpayers aren't subjected to a higher marginal rate as a result of inflation.

## CPI-U Formula

The more common CPI-U calculation entails two primary formulas. The first is used to determine the current cost of the weighted average basket of products, while the second is used to analyze the [year-over-year (YOY)](https://www.investopedia.com/terms/y/year-over-year.asp) change.

To calculate the annual CPI, the BLS divides the current value of a specific basket of goods compared to one year ago:

> $\begin{aligned}\text{Annual CPI}=\frac{\text{Value of Basket in Current Year}}{\text{Value of Basket in Prior Year}}\times 100\end{aligned}$

The basket of goods and services used in the CPI calculation is a [composite](https://www.investopedia.com/terms/c/composite.asp) of popular items commonly purchased by Americans.

The weight of each component of the basket is in proportion to how they are sold. The annual CPI is reported as a whole number, and the figure is often greater than 100, assuming current market prices are appreciating.

Then, the BLS uses the current year's CPI and the prior year's CPI to calculate the inflation rate.

> $\begin{aligned}\text{Inflation Rate} = \frac{\text{New CPI} - \text{Prior CPI}}{\text{Prior CPI}}\times100\end{aligned}$

The inflation rate can be calculated for a given month or annual period; in either case, the appropriate new and prior period must be selected.

The inflation rate is reported as a percentage and is often positive, indicating current market prices are appreciating.  

![The 8 Major Groups of the Consumer Price Index](https://www.investopedia.com/thmb/7e1R1qXbYK3NnHk3b_YzrjlXEF4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/consumerpriceindex-FINAL-700b87f61f1441419c9d1562e6537f86.png)

*— Investopedia / Maddy Price*

## CPI Categories

The [monthly CPI release](https://www.bls.gov/news.release/cpi.nr0.htm) from the BLS leads with the change from the prior month for the overall CPI-U as well as its key subcategories, along with the unadjusted change year-over-year.

The BLS' detailed tables show price changes for a variety of goods and services organized by eight umbrella spending categories.

Subcategories estimate price changes for everything from tomatoes and salad dressing to auto repairs and sporting events tickets. Price changes for each subcategory are provided with and without [seasonal adjustment](https://www.investopedia.com/terms/s/seasonal-adjustment.asp).

BLS also publishes CPI data for U.S. regions, sub-regions, and major metropolitan areas. The metro data is subject to wider fluctuations and is useful mainly to identify price changes based on local conditions.

The table below represents the CPI basket weighted distribution for food, energy, and all other items. Category weightings may change, depending on the speed at which prices are rising.

## Using the CPI

The CPI is widely used by financial market participants to gauge inflation and by the Federal Reserve to calibrate its monetary policy.

Businesses and consumers also use the CPI to make informed economic decisions. Since CPI measures the change in consumers' [purchasing power](https://www.investopedia.com/terms/p/purchasingpower.asp), it is often a key factor in pay negotiations. 

*   **The Federal Reserve:** The Fed uses CPI data to determine economic policy. With a [target inflation rate](https://www.investopedia.com/terms/i/inflation_targeting.asp) of 2%, the Fed may enact expansionary monetary policy to stimulate the economy should market growth slow, or enact contractionary monetary policy should the economy grow too quickly. In response to higher-than-desired inflation rates via the CPI, the Fed adjusts the [Fed funds rate](https://www.investopedia.com/terms/f/federalfundsrate.asp).
*   **COLAs:** The [cost-of-living adjustments (COLAs)](https://www.investopedia.com/terms/c/cola.asp) based on the CPI affect federal payments to the many millions of Americans receiving Social Security and [Supplemental Security Income (SSI)](https://www.investopedia.com/terms/s/ssi.asp) benefits. They also apply to federal pension payments, school lunch subsidies, and income tax brackets.
*   **Housing:** Mortgage rates and long-term debt are often impacted by rates set by government agencies. As the CPI increases and the government enacts policy changes to slow inflation, rates often increase. Landlords may use CPI information to adequately assess what annual rent increases for renters should be.
*   **Financial markets:** Financial market prices can react to the CPI, as reactionary Fed policies directly impact economic growth, corporate profits, and consumer spending ability. A higher CPI often means that a less stringent government policy is generally in place. Debt is easier to obtain and individuals have greater spending capacity. Lower or decreasing CPI may indicate that the government may ease policies that help boost the economy.
*   **Labor:** The CPI and its components support changes in hourly or weekly earnings. Employees may turn to CPI reports when approaching their employers for a raise based on nationwide increases in labor rates as well as pricing. Some workers covered by [collective bargaining](https://www.investopedia.com/terms/c/collective-bargaining.asp) agreements may have their [contracts and wages tied to changes in CPI](https://www.investopedia.com/ask/answers/011915/how-consumer-price-index-cpi-used-market-escalation-contracts.asp).  
    

> **Fast Fact**
>
> The BLS reports the CPI on a fixed, monthly basis at 8:30 a.m. Eastern time. A schedule of prior and future releases can be found on the BLS website.

## How Does the CPI Affect Unemployment Rates?

In the broadest sense, the CPI and unemployment rates are often inversely related. The Federal Reserve often attempts to decrease one metric while balancing the other. For example, in response to the COVID-19 pandemic, the Federal Reserve took unprecedented supervisory and regulatory actions to stimulate the economy.

As a result, the labor market strengthened and returned to pre-pandemic rates by March 2022; however, the stimulus resulted in the highest CPI calculations in decades. When the Federal Reserve attempts to lower the CPI, it runs the risk of unintentionally increasing unemployment rates.

## How Is the Consumer Price Index Used?

The CPI Index is an inflation indicator closely watched by policymakers and financial markets. A related CPI measure is used to calculate cost-of-living adjustments for federal benefit payments.

## What Are Some Criticisms of the CPI?

The CPI-U calculation only measures inflation for urban populations and remains a less-than-reliable source of data for individuals living in rural areas. The CPI does not explicitly state how different demographics may be impacted by inflation.

For example, soaring education costs may adversely impact younger individuals, while the impact of increasing elderly care costs is felt by a different group of individuals. Lower-income individuals who contribute more gross income towards necessities of shelter and food will skew differently than households with larger disposable income. For this reason, the CPI may not adequately reflect each individual's experience about costs and changes over time.

## The Bottom Line

The Consumer Price Index measures the average change in prices paid by consumers over time for a basket of goods and services. The index is calculated and published monthly by the Bureau of Labor Statistics.

It is a common measure of inflation, indicating the health and direction of the economy. It also serves in other capacities, notably to help make adjustments to certain income payments, such as Social Security and pensions for federal civil service retirees.

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