The CPI and an Individual's Cost of Living


Read: "The Consumer Price Index--Why the Published Averages Don't Always Match An Individual's Inflation Experience."

Questions:

  • Why does the mix of goods that you buy determine how well the CPI explains the effect of inflation on the purchasing power of your income?

  • Why does geographical location have an effect on how well the CPI measures changes in your cost of living?

  • Suppose that the price of heating oil rises at twice the rate of inflation. For which portions of the country would the CPI overstate the effect of inflation? For which portions of the country would the effect of inflation be understated?



  • If the cost of the bundle of goods that you buy rises more rapidly than the cost of the bundle of goods purchased by a typical household, then your cost of living will be understated by the change in the CPI. The change in your cost of living is overstated if the cost of your bundle of goods doesn't rise as quickly as the cost of the bundle used to compute the CPI.

  • Individuals in different geographical locations have different expenditure patterns. Furthermore, rents, fuel prices, food prices, etc. sometimes change at different rates in different parts of the country (at least in the short run).

  • The CPI will overstate the effect of this price increase in those parts of the country in which a typical household uses a below average amount of heating oil (i.e.,southern states). The CPI will understate the impact of this change in the northern states in which a larger portion of household budgets is spent on heating oil.

Economics

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