Welcome to the new Academic year.

This is for grade 10. you can refer this notes for the knowing how CPI is calculated....

Q. How the inflation / CPI is calculated?

A consumer price index (CPI) measures changes in the price level of consumer goods and services purchased by households. The CPI in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services."

The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. Sub-indexes and sub-sub-indexes are computed for different categories and sub-categories of goods and services, being combined to produce the overall index with weights reflecting their shares in the total of the consumer expenditures covered by the index. It is one of several price indices calculated by most national statistical agencies. The annual percentage change in a CPI is used as a measure of inflation.

The Proportion of total household expenditure sent on each good or services is used to weight their individual price. For example, if the price of a loaf of bread is $2 & the typical household spent 5% of their weekly or annual spending on bread, then the weighted average price will be $2 X 0.05 = $0.10. Prices are weighted in this way because the more a household spends on a particular goods or services the more an increase in the price of that product will matter.

In the first year of measurement – the Base Year -  the weighted average price of all goods & services in the CPI basket is calculated & set equal to 100. Monthly or annual changes in the weighted average price of the basket are then compared to the base year.

Calculating a CPI – a simple example

Imagine the ‘basket’ used to calculate a CPI consists of three main products: food, travel & clothing.

YEAR1 ( Base Year)

Products	Avg. Price($)	Proportion of household expenditure spent on each product(%)	Weighted average price	Price index
Food	$60	60%	0.60 X $60 = $36
Travel	$20	10%	0.10 X $20 = $2
Clothing	$40	30%	0.30 X $40 = $12
		Total =100%	Average price of basket = $50	=100

YEAR1 ( Base Year)

Products	Avg. Price($)	Proportion of household expenditure spent on each product(%)	Weighted average price	Price index
Food	$70	60%	0.60 X $70 = $42
Travel	$40	15%	0.15 X $40 =  $6
Clothing	$48	25%	0.25 X $48 = $12
		Total =100%	Average price of basket = $60	=120

Weighted average price year2            $60

CPI Year2 = --------------------------------------------    =   ------- X 100  = 120 i.e. the annual inflation is 20%.

                       Weighted average price year1            $50

The CPI also has a number of specific applications:

(1) It is used to escalate a given dollar value, over time, to preserve the purchasing power of that value. Thus, the CPI is widely used to adjust contracted payments, such as wages, rents, leases and child or spousal support allowances. Private and public pension programs (Old Age Security and the Canada Pension Plan), personal income tax deductions, and some government social payments are also escalated using the CPI.

(2) It is used as a deflator of various economic aggregates, either of income flows, to obtain constant dollar estimates of income, or of expenditure flows, to obtain personal expenditure estimates at constant prices.

(3) It is used to set and monitor the implementation of economic policy. The Bank of Canada, for example, uses the CPI, and special aggregates of the CPI, to monitor its monetary policies and to gauge their effectiveness in containing inflation within its target range. The CPI and its component indexes may also be used to assess the effect of various public policies (e.g., agricultural policy and food prices).

(4) Business analysts and economists use the CPI for economic analysis and research on various issues, such as the causes and effects of inflation, and understanding regional disparities in price movements.

Price movements of the goods and services represented in the CPI are weighted according to the relative importance of goods and services in the total expenditures of consumers. Each good or service is considered to be an element in a fictitious basket, and price movements are assigned a basket share or weight commensurate with the proportion of total consumption expenditure they account