Cost of Living Index (Consumer Price Index)

A Cost of Living Index, also called a Consumer Price Index (CPI), measures the average change in the prices of a fixed 'basket' of goods and services that a particular group of consumers (industrial workers, agricultural labourers, urban non-manual employees, and so on) typically buys. Unlike a general wholesale price index, a CPI is built specifically to answer: has it become more expensive for this group of people to maintain their usual standard of living?

The standard construction method is the Family Budget Method, which is really a weighted average of price relatives, using each item's share of total household expenditure in the base year as its weight $w$:

The weights $w$ typically come from a household expenditure survey, and the basket usually groups items under heads such as Food, Clothing, Fuel & Lighting, Housing, and Miscellaneous.

Main uses of the CPI:

1. Adjusting wages and dearness allowance — many wage agreements and government pay scales tie periodic increases directly to CPI movements, so that real (inflation-adjusted) wages do not fall as prices rise.
2. Adjusting pensions and social-security payments for the same reason.
3. Measuring the purchasing power of money — the reciprocal of the CPI (times 100) gives the purchasing power of the rupee relative to the base year.
4. Deflating income and other value series to compare them in real terms across years. …