The consumer price index (CPI) measures food; beverages; housing; apparel; transportation; medical care; recreation; education and communication; and other goods and services. It is one of the most-used economic indicators to measure inflation in the United States, as it calculates the change in cost on a bundle of consumer goods and services over time. Inflation shows the change in the purchasing power of the dollar. Higher sale prices indicate a decrease in consumer purchases and a rise in inflation, eventually leading to adjustments in income and the cost of living – a process referred to as indexation.
The CPI is broken down into two subcategories to measure price changes in domestic and imported consumer-related services. Residents of urban or metropolitan areas, including professionals, the self-employed, the poor, the unemployed and the retired, are measured using the Consumer Price Index for All Urban Consumers (CPI-U). Urban wage earners and clerical workers are measured using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a more specific category that skews more towards active workers and those in the lower social classes
As the CPI does not include rural or non-metropolitan areas, farm families, members of the armed forces and those in institutions such as prisons and mental hospitals, the U.S. Bureau of Labor Statistics (BLS) uses additional indexes to measure inflation. The producer price index (PPI), which measures the domestic output of raw goods and services, serves as a leading indicator for the CPI; when producers face input inflation, the increase in their production costs are passed on to the retailers and consumers.
Hence, the PPI serves as a true measure of output; it is not affected by consumer demand. The gross domestic product (GDP) deflator measures the aggregate prices of all goods and services produced by the entire nation encompassing the CPI and the PPI statistics. The CPI is a sound index to measure inflation, but for a more accurate and comprehensive measure, the PPI and the GDP deflator are also required.