Inaccuracies Of The Consumer Price Index (CPI) Essay, Research Paper

Inaccuracies of the Consumer Price Index (CPI)

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.