Chain-Weighted CPI

What is the 'Chain-Weighted CPI'

An alternative measurement for the Consumer Price Index (CPI) that considers product substitutions made by consumers and other changes in their spending habits. The chain-weighted CPI is therefore considered to be a more accurate inflation gauge than the traditional fixed-weighted CPI, because rather than merely measuring periodic changes in the price of a fixed basket of goods, it accounts for the fact that consumers’ purchasing decisions change along with changes in prices. Because the fixed-weighted CPI may consistently overstate inflation by ignoring the disinflationary effect of quality improvements and new technology, in addition to the substitution effect, the U.S. Bureau of Labor Statistics maintains that the chain-weighted CPI is a closer approximation to a cost-of-living index than other CPI measures.
 

BREAKING DOWN 'Chain-Weighted CPI'

For example, consider the impact of two similar and substitutable products – beef and chicken – in the shopping basket of Mrs. Smith, a typical consumer. (Let’s ignore for the moment the fact that the "core" inflation rate ignores food and energy prices because they are too volatile.) Mrs. Smith buys two pounds of beef at $4 / lb. and two pounds of chicken at $3 / lb. A year later, the price of beef has risen to $5 / lb. while the price of chicken is unchanged at $3 / lb. Mrs. Smith therefore adjusts her spending pattern because of the higher price of beef, and buys three pounds of chicken, but only one pound of beef.
 
The fixed-weighted CPI measure would assume that the composition of Mrs. Smith’s shopping basket is unchanged from a year earlier, and would compute the inflation rate as 14.3% (i.e. the difference between the total price of $14 and $16 paid for two pounds of beef and chicken a year apart). The chain-weighted CPI measure would, however, consider the effect of Mrs. Smith substituting a pound of beef with a pound of chicken because of its lower price, and would compute the inflation rate as zero (because the total amount spent is unchanged at $14).
 

RELATED TERMS
  1. Substitution Effect

    The idea that as prices rise (or incomes decrease) consumers ...
  2. Chicken

    An investor who is petrified of incurring losses from investing. ...
  3. Basket Of Goods

    A relatively fixed set of consumer products and services valued ...
  4. Substitute

    A product or service that a consumer sees as comparable. If prices ...
  5. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket ...
  6. Marginal Rate of Substitution

    The amount of a good that a consumer is willing to give up for ...
Related Articles
  1. Retirement

    Economic Indicators: Consumer Price Index (CPI)

    By Ryan Barnes Release Date: Monthly, approximately mid-month Release Time: 8:30am Eastern Standard Time Coverage: Previous ...
  2. Markets

    Heat Up Your Portfolio With "BBQ" Stocks (HRL,TSN)

    Americans eat a lot of chicken and beef consumption is on the rise so you might want to consider these "BBQ" stocks to heat up your portfolio.
  3. ETFs & Mutual Funds

    How To Trade Rising Beef Prices

    After a lull in early August, beef prices are set to rise again. Here's advice on how to place some bullish bets.
  4. Markets

    Understanding the Substitution Effect

    The substitution effect is an economic term used to describe consumer behavior relative to price or income changes.
  5. Retirement

    Why The Consumer Price Index Is Controversial

    Find out why economists are torn about how to calculate inflation.
  6. Retirement

    Inflation: How Is It Measured?

    Measuring inflation is a difficult problem for government statisticians. To do this, a number of goods that are representative of the economy are put together into what is referred to as a "market ...
  7. Markets

    What's a Substitute?

    A substitute is a good that satisfies the same needs as another.
  8. Trading

    The Consumer Price Index

    Find out how this economic measure can help you make key financial decisions.
  9. Markets

    Why Inflation Feels Higher Than the Fed's Target Rate

    Follow the monthly readings on core PCE inflation in the Personal Income and Outlays reports to understand the Federal Reserve's inflation assessments.
  10. Markets

    5 Government Statistics You Can't Trust

    Government economic statistics carry a lot of weight, but there are some significant gaps in the methodology.
RELATED FAQS
  1. What are some limitations of the consumer price index (CPI)?

    Explore some of the basic limitations of the widely used economic indicator, the consumer price index, or CPI, and examine ... Read Answer >>
  2. Will the consumer price index (CPI) be updated or revised in the future?

    Learn about the consumer price index (CPI) and understand how its purpose and calculation make it necessary to continually ... Read Answer >>
  3. Does the consumer price index (CPI) correlate with the change in price of goods and ...

    See why the consumer price index is a questionable proxy for inflation, and why it is unlikely to represent experiences with ... Read Answer >>
  4. What's the difference between the substitution effect and price effect?

    Learn how the increase in an item's price affects consumer demand. Explore the differences between the substitution and price ... Read Answer >>
  5. Should a small business test the substitution effect on its products before launch?

    Explore the substitution effect and find out how small businesses may evaluate how this principle impacts their own products. ... Read Answer >>
  6. What's the difference between the substitution effect and the income effect?

    Learn the difference between the income effect and the substitution effect in terms of spending money. Predict which direction ... Read Answer >>
Hot Definitions
  1. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  2. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  3. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  4. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  5. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
  6. Weighted Average Life - WAL

    The average number of years for which each dollar of unpaid principal on a loan or mortgage remains outstanding. Once calculated, ...
Trading Center