What is the Consumer Price Index and how does it work?

The Consumer Price Index (CPI) is an important economic indicator, especially for retirees. It plays a very important part in YourLifeChoices’ quarterly Retirement Affordability Index as well.

But how does the CPI work and how is it measured?

The CPI figures are produced by the Australian Bureau of Statistics (ABS) quarterly (the three months ending March, June, September and December and was first compiled in 1960.

The figures measure the average change over time in the prices paid by households for a fixed basket of goods and services.

The CPI provides the government and other groups with a general measure of changes in prices of consumer goods and services purchased by Australian households.

The CPI is used for a variety of purposes, such as in the development and analysis of government economic policy and the adjustment of some government benefits including the Age Pension. Economists use it to monitor and evaluate levels of inflation in the Australian economy.

The value of many types of fixed payments, such as the Age Pension, can be reduced over time when prices rise.

The government uses CPI to adjust these payments to counter the effects of inflation, a process referred to as ‘indexation’.

What is included in the basket of goods?
For practical reasons, the basket cannot include every item bought by households but it does include the most significant items.

It is not necessary to include all the items people buy since many related items are subject to similar price changes.

The idea is to select representative items so that the index reflects price changes for a much wider range of goods and services than is actually priced.

When determining what items are to be priced for the CPI basket, various factors are taken into consideration. Items:

  • must be representative of purchases made by the CPI population group
  • must have prices that can be associated with an identifiable and specific commodity or service (for example, a 420g can of baked beans, or adult general admission to a club football game)
  • are not excluded on the basis of moral or social judgements. For example, some people may regard the use of tobacco or alcohol as socially undesirable, but both are included in the CPI basket because they are significant items of household expenditure and their prices can be accurately measured.

The total basket is divided into 11 major groups, each representing a specific set of commodities:

  • food and non-alcoholic beverages
  • alcohol and tobacco
  • clothing and footwear
  • housing
  • furnishings, household equipment and services
  • health
  • transport
  • communication
  • recreation and culture
  • education
  • insurance and financial services.

These groups are divided in turn into 33 sub-groups, and the sub-groups into 87 expenditure classes. An expenditure class is a grouping of similar items, such as various types of motor vehicles.

Does the CPI have a direct relationship to your expenses?
The CPI is not designed to measure price levels; rather its purpose is to measure changes in prices over time.

While price levels in country regions often differ from those in metropolitan areas (some higher and others lower), the factors influencing price movements generally tend to be similar. Therefore, the CPI can be expected to provide a reasonable indication of the changes in prices in Australia as a whole over the longer term.

At the end of the day, the CPI is most useful as an indicator of price movements, whether it be for specific items, a particular city, or the economy as a whole. The CPI is not a precise measure of individual household price experiences.

For more information on the CPI and how it is measured, visit abs.gov.au

Do you think using the CPI to index increases to the Age Pension is a sufficient way to ensure pensioners are not disadvantaged by rising inflation costs? Could you think of a better system?

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Related articles:
https://www.yourlifechoices.com.au/finance/news-finance/weve-stockpiled-more-than-200-billion-of-extra-savings
https://www.yourlifechoices.com.au/finance/what-the-new-consumer-law-changes-mean-for-your-rights
https://www.yourlifechoices.com.au/finance/superannuation/news-superannuation/how-did-your-super-fund-perform-in-2020

Written by Ben

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