Foundationsexplainers
How Inflation Is Measured: CPI, Baskets, and Indexes
Learning objectives
- Explain how a consumer price index is constructed
- Describe the basket-of-goods method and weighting
- Interpret what an index value like 310 means
- List the main limitations of inflation measurement
The basket idea
Statistical agencies track inflation by pricing a fixed 'basket' of goods and services that represents typical household spending — food, housing, transport, healthcare, and more. Each item gets a weight matching its share of spending. Field collectors and scanners record prices monthly, and the index compares today's basket cost with a base period.
CPI = (cost of the basket today / cost in base year) x 100.
Weights matter
Housing usually carries the largest weight in consumer baskets, so rent moves the index more than, say, movie tickets. Weights come from household expenditure surveys and are updated every few years. When weights lag behind changing habits — like the shift to streaming — the index can misread real spending patterns until rebasing.
Reading the numbers
An index value of 310 against a base of 100 means prices have roughly tripled since the base year. The inflation rate is the percentage change in the index over 12 months. Core inflation strips out volatile food and energy to reveal the underlying trend, which is why central banks watch it closely.
What the index misses
Indexes struggle with quality change (a better phone at the same price is effectively cheaper), new products, substitution (shoppers switch to cheaper brands), and outlet shifts. Statisticians adjust for these with hedonic methods and chained formulas, but no single number captures everyone's experience — your personal inflation depends on your own basket.
This article explains measurement concepts. It is not financial advice.
Key points
- CPI tracks a representative basket of household spending
- Weights reflect spending shares; housing usually dominates
- Inflation rate = 12-month percent change in the index
- Core inflation excludes volatile food and energy
- Your personal inflation depends on your own basket
Common misconceptions
✓ Truth: It measures a representative basket; no index prices literally every transaction in the economy.
✓ Truth: If wages rise faster than prices, real living standards improve even as the index climbs.
✓ Truth: They matter to households; core just reveals the underlying trend by removing the most volatile components.
Frequently asked questions
Who computes the CPI?
National statistical agencies — such as the Bureau of Labor Statistics in the US or the ONS in the UK — using price surveys, scanner data, and expenditure weights.
What is the difference between CPI and the GDP deflator?
CPI covers consumer purchases with fixed weights; the GDP deflator covers all domestically produced goods and services with changing weights.
Why do people feel inflation is higher than reported?
People notice frequently bought items like groceries and fuel, overweight salient price rises, and have baskets that differ from the average.
How often are baskets updated?
Typically every few years from expenditure surveys; some countries now update weights annually using scanner data.