By Jonny Lupsha, Wondrium Staff Writer
The Consumer Price Index indicates the overall price of household items. It’s determined by consumer purchasing behavior and compared to previous years. Inflation of this price index has reached a 30-year high.
The Consumer Price Index (CPI) for October 2021 is 6.2% higher than it was in October 2020. Prices of consumer goods seem to be rising everywhere, leading to the worst inflation since 1990. Some of the many factors involved include rising fuel costs, ongoing supply chain issues, and landlords raising rent for tenants.
Higher costs of living stretch budgets and even cause panic among consumers. Wages aren’t tied to inflation, so while one’s salary may have stayed the same or seen an incremental raise from October 2020 to October 2021, odds are their buying power has become weaker.
In his video series Money and Banking: What Everyone Should Know, Dr. Michael K. Salemi, Professor of Economics at The University of North Carolina at Chapel Hill, explained the CPI and inflation.
Understanding the Consumer Price Index
“The CPI is properly thought of as the index of the price of a bushel basket—a bushel basket full of the goods chosen by the typical family of four that lives in some city of the United States,” Dr. Salemi said. “The bushel basket prices in each month are each divided by the bushel basket price in some base year, and that base year is currently 1983.”
The contents of the hypothetical bushel basket are decided by consumers. The Bureau of Labor Statistics of the U.S. Department of Labor frequently conducts surveys to understand the nation’s buying habits. Of course, in 1983, nobody was buying smartphones or tablets. Therefore, the contents of the bushel basket are changed very slowly so the CPI reflects changes in prices of existing items more than it quickly compensates for enormous technological innovations.
The CPI is not also directly equivalent to a cost-of-living index. Why not?
“Savvy consumers will move away from the items that have experienced high price increases and toward items that are good substitutes and have experienced smaller price increases,” Dr. Salemi said. “Suppose there is a frost in Georgia and that greatly increases the price of peaches. I like peaches.
“You like peaches, but if the price of peaches goes very much higher, you and I and consumers in general are likely to substitute nectarines or some other fruit for the peaches that are now very expensive.”
The cost of eating fruit won’t rise by the same amount as the cost of eating peaches.
Inflation is the rate of growth in a price index. If the CPI is a number that defines the cost of a bushel basket of goods at a moment in time, the inflation rate tells us how that number is growing and at what speed. There are many ways to compute an overall inflation rate, but using the CPI on a year-to-year scope for any particular month is very often put into use.
Economist Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” Dr. Salemi pointed out that the key is that inflation is only caused by that money growth which exceeds the rate of a nation’s productivity.
“Friedman said that an increase in the growth rate of money puts additional buying power in the hands of potential spenders,” he said. “For example, if the increase in money growth resulted from a decision by a government to buy additional defense-related products, defense contractors and those who work for them would receive additional money.
“When [they] spend the additional money that they have received, they bid up the prices of the goods they buy.”
Since the variety of goods they buy is so wide, most prices rise and inflation results.