Chain-Weighted CPI

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DEFINITION of '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).
 

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