Essay/Term paper: Inaccuracies of the consumer price index(cpi)

Essay, term paper, research paper:  Economics

Inaccuracies of the Consumer Price Index(CPI)

Aman Aggarwal
Sept. 28, 1996

The Consumer Price Index is a measure of the prices of a fixed market
basket of some 300 consumer goods and services purchased by a "typical" urban
consumer. The 1982-1984 period serves as the base period so analysts can compare
other year's changes with this base period. The composition of the market
basket is fixed in the base period and is assumed not to change from one period
to another. The reason for the assumption is because the CPI measures the
costliness of a constant standard of living. Critics claim that the CPI is
inaccurate because it overstates the increases in the cost of living. For this
reason, the CPI has been said to be inaccurate.
First, consumers do change their spending patterns. Even though the
composition off the market basket is assumed not to change, it does because
consumers change their spending patterns. Because consumers substitute lower
priced products in lieu of higher priced ones, the weight has shifted. The CPI
assumes that this does not occur and therefore it overcompensates the standard
of living.
Secondly, because the base period was over a decade ago, the quality of
the products has increased significantly, and therefore the prices should be
higher. The CPI, however, assumes that the increases in prices is a result of
inflation rather than quality improvements which is false. Here also, the CPI
overstates the rate of inflation.
Many consumers do not mind the overcompensation of the CPI because in
most cases it means more money in their pockets, but there are some consequences.
This may cause an ongoing inflation trend. The reason why the government does
not restrict it is because they are worried about getting re-elected. Even if
the President does call for a revision of the CPI, Congress would defeat it to
keep their positions.
Another consequence of the overstated CPI involves the adjustment of tax
brackets. Their intent of indexing is to prevent inflation to cause people to be
placed into a higher tax bracket. For example, if your income increases by 10%,
that may put you in a higher level tax bracket, but if product prices have also
increased by 10%, your real income has remained constant. This would transfer
money from taxpayers hands to the Federal Government. However, indexing will
tend to reduce the Federal Government's share by raising the levels of the tax
brackets. Therefore, more money will stay in the people's hands due to indexing.
The only party that seems to be hurting as a result of the
overcompensation of the CPI is the Federal Government. Because consumers are the
ones that are being affected, they control the CPI as opposed to the Federal
Government.