What Is a Basket of Goods?
The consumer price index (CPI), a common measure of inflation, measures the price change over time for a basket of goods and services. The basket is representative of consumer spending patterns, and the change in its price represents the rate of inflation faced by consumers as a whole.
For example, if the basket's price has increased 5% in the course of the year, consumer inflation can be said to be running at a 5% annual rate. The definition and contents of the measured basket can vary widely by country.
In the U.S., the Bureau of Labor Statistics (BLS) monthly collects the prices of some 94,000 items from a scientifically selected sample of goods and services to assemble its representative basket. The numbers are then adjusted to ensure price changes don't reflect improvements in product quality, and weighted in proportion with consumer spending patterns derived from a separate survey of about 36,000 consumers in a given year.
- A basket of goods represents consumer spending and is used to track changes in the prices of consumer goods and services over time.
- The Bureau of Labor Statistics tracks 94,000 prices monthly to assess inflation for more than 200 categories of products and services
- The U.S. CPI basket includes a 33.3% weighting for shelter costs derived mostly from rents and owners' equivalent.
- CPI calculations factor in consumer substitution of items rising in price with alternatives and filter out price increases reflecting product improvements.
Basket of Goods Deconstructed
With 94,000 prices sampled monthly, the BLS is using a huge basket, because its goal is to get an accurate measure of price changes for consumer goods and services across the U.S. economy.
Broad consumer spending categories like food, energy, apparel and services include subcategories tracking inflation for everything from apples and premium unleaded gasoline to men's underwear and funerals.
The prices of goods and services are gathered mostly from visits by BLS data collectors to some 23,000 retail and service outlets in 75 urban areas.
Items for sampling at each outlet are selected randomly based on odds proportional to how much spending they attract relative to category alternatives in terms of brand, variety and size or weight. Items remain in the sample for four years.
Housing rents and owners' equivalent are based on a survey of rents from 43,000 rental housing units. They make up the bulk of the shelter category, which has a 33.3% weight in the U.S. CPI.
How the Government Calculates CPI
After the prices are collected, BLS product specialists make adjustments to ensure the price changes are measuring inflation rather than the cost of product improvements in items such as autos, consumer appliances and electronics.
The prices are used to calculate basic indexes for 211 goods, services, and housing item categories for 32 geographic areas subdividing all U.S. urban areas. The BLS then calculates more than 7,700 item-area combination basic indexes in a way that factors in the substitution of cheaper items for more expensive ones within and between spending categories.
All those item-area indexes are then weighed based on recent two-year results from a detailed consumer spending survey to calculate two versions of the consumer price index.
The CPI for All Urban Consumers (CPI-U) reflects the spending patterns of the approximately 93% of U.S. population living in areas where the BLS collects price data. It is the basis of the headlines about the rate of change in consumer prices, or the inflation rate.
The CPI for Urban Wage Earners and Clerical Workers (CPI-W) covers 29% of the population, and is limited to households with income derived predominantly from clerical or wage-paying occupations. The CPI-W is used to adjust for inflation the payments due Social Security beneficiaries, military and federal civil service retirees, and food stamps recipients, as well as to adjust federal income tax brackets.
How Does CPI Relate to Inflation?
Although the terms CPI and inflation are often used interchangeably, the CPI only measures inflation as experienced by consumers. Other data measure alternative manifestations of inflation. The producer price index (PPI) measures the change in the prices paid by producers, while the employment cost index assesses inflation in the labor market. The BLS also tracks changes in imports and exports prices, while the gross domestic product price deflator is a measure of inflation across the U.S. economy, including exports but not imports.
Real World Example
The U.S. CPI (shorthand for the CPI-U measure for all urban consumers) rose 1.2% in March 2022 and was up 8.5% in the preceding 12 months. Gasoline prices rose more than 18% in March, accounting for more than half of the rise in the CPI, following Russia's invasion of Ukraine. The so-called core CPI excluding the typically more volatile food and energy prices was up 0.3% in March and 6.5% year-over-year.
Because inflation imposes economic costs in terms of added uncertainty, policymakers aim to keep it under control. They often use changes in the representative basket of goods and services as measured by the CPI as one of the benchmarks in setting monetary policy. In the U.S., the Federal Reserve aims for a 2% annual inflation rate, which it has determined is most compatible with its mandate to promote stable prices and maximum employment.
In raising its target for the federal funds rate to a range of 0.75% to 1% in May, the Federal Reserve's Federal Open Market Committee (FOMC) said it expected inflation to return to 2% "with appropriate firming in the stance of monetary policy." In the meantime, "ongoing increases in the target range will be appropriate," the FOMC added.