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Theses, Dissertations, Professional Papers
Graduate School
1982
The Consumer price index : what is it and how it
can work for you
Mark J. Whetstone
The University of Montana
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THE CONSUMER PRICE INDEX— WHAT IS IT AND
HOW IT CAN WORK FOR YOU
By
Mark J. Whetstone
B.A., University of Cincinnati, 1978
Presented in partial fulfillment of the requirements for
the degree of
Master of Business Administration
UNIVERSITY OF MONTANA
1982
Chaivma^r^Board of Examiners
Dean, Graduate Scfrool
D a te
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TABLE OF CONTENTS
List of Tables..............................................
iv
Chapter
I.
PURPOSE AND ORGANIZATION................................
1
Problem Statement
Purpose of Research
II.
THE CONSUMER PRICE INDEX................................
3
Introduction
■'History of the CPI
First Major Revision - 1940
The 1953 Revision
The 1978 Revision
Future Revisions
What is the Consumer Price Index
The Three Basic Elements of the CPI
The Consumer Expenditure Survey
The Point-of-Purchase Survey
Improved Statistical Methods
V Calculation of the CPI
Illustrative Example
Problems in Constructing a CPI
The Index Population
Quality Changes in the Market Basket
Seasonal Adjustment
Limitations of the CPI
Uses of the CPI— What the Worker-Consumer Should Know
III.
THE ACCRA INTER-CITY COST-OF-LIVING INDEX ...............
Development of the ACCRA Index
Computation of a ACCRA Cost-of-Living Index
11
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21
I l l
What the ACCRA Index Tells Us
What the ACCRA Index Doesn’t Tell Us
The ACCRA Index Versus the Consumer Price Index
Using the ACCRA Index
IV.
RESULTS AND FINDINGS..................................
33
Restatement of the Problem
Additional Research
V.
CONCLUSIONS..........................................
BIBLIOGRAPHY.
.............................................
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35
38
LIST OF TABLES
Table
1. Changes in the Weighting Pattern Over
theYears..........
11
2. How the CPI is Calculated..............................
14
3. ACCRA City Composite Index First Quarter,
1979...........
24
4. Table of an ACCRA Price Report..........................
26
5. Table for an ACCRA Price Report.........................
27
IV
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CHAPTER I
PURPOSE AND ORGANIZATION
Problem Statement
The Consumer Price Index (CPI) or ’cost-of-living index’
frequently makes headlines in newspapers and on TV news programs.
It
is probably the most widely used consumer statistic in the nation, and,
as Such, it is used as the principal measure of inflation in the U. S.
economy.
However, computation of the index and its limitations are not
understood by most consumers and businesses.
This index determines our
inflation rate, cost of living adjustments and other economic adjust­
ments.
It also indicates where most of our hard earned money is spent
and how much of the goods and services we get for our dollars (thus, our
standard of living). Therefore it is important that each consumer under­
stands this almost daily heard concept:
The Consumer Price Index.
Another important index is the American Chamber of Commerce
Researchers Association (ACCRA) cost-of-living index.
widely known or heard of, compared to the CPI.
This is less
This index measures living
cost differences among participating cities at a given point in time.
The
method as to how it is prepared for a city such as Great Falls and what it
indicates can be very valuable information for consumers.
This study addresses the problem of what these indexes are and
how they can be used.
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Purpose of the Research
The primary objectives of this research are a description and
history of the Consumer Price Index and the ACCRA Inter-City Cost-ofLiving Index.
An analysis of how the CPI and ACCRA Indexes are calculated,
and the problems encountered in preparing these indexes has been made.
Most important of all, an explanation of how these indexes can be used
by the average consumer has been provided.
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^
CHAPTER II
THE CONSUMER PRICE INDEX
Introduction to the Consumer Price Index
Economics was once an academic discipline pursued only by theor­
ists.
At that time the Consumer Price Index (CPI) was merely a research­
er's tool, and the term 'price index' was not part of the average American's
vocabulary.
Today, economics is a household exercise in budgeting and
investment, and the CPI is discussed at the dinner table as well as at
the conference table.
The effects of the index extend beyond the increase
in income which is triggered for workers under contracts with CPI related
S
''
excalator
clauses.
Americans have more than a personal interest in this
monthly statistic that receives front page coverage; their interest
concerns national economic well-being.
Over the years the CPI has grown
in popularity, as the Bureau of Labor Statistics analysts have altered
its concepts and content, to meet the needs of its users.
History of the CPI
Different government agencies have been studying prices and
living conditions since the late 19th Century.
But it was not until
World War I that the first CPI, called a cost-of-living index, grew out
of a decision by the Shipbuilding Labor Adjustment Board.
In arriving
at a 'fair wage scale,' the Board determined in November 1917, that wages
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4
in the shipbuilding yards should be adjusted when the cost of living had
increased generally.
During 1918-19, the Bureau investigated the cost
of living in a number of shipbuilding and other industrial centers.
Details of expenditures on goods in the family market basket were obtained
from each of 12,000 wage-earner families in 92 cities, and records of
retail establishments in 32 cities provided prices for a large number of
items.
Regular price collection was initiated after 1917 in these 32
cities, with price information collected one to four times a year for
about 145 commodities and services.
In 1919, the Bureau began to publish
complete 'cost-of-living’ indexes at semiannual intervals for 32 large
shipbuilding and industrial centers, using a weighting structure based
on data collected in the expenditure survey of wage-earner and clericalworker families in 1917-19.
In February 1921, publication of the National Consumer Price Index
in roughly its present form was established.
Quarterly indexes began in
October 1940 at the request of the National Defense Advisory Commission.
Although many changes in coverage and publication format have occurred
over the years, the index has continued to measure changes in the price
of a fixed market basket of goods and services.
First Major Revision - 1940
In 1933, the Secretary of Labor requested that the American
Statistical Association appoint a committee to advise the Department of
Labor on its statistical programs.
The Advisory Committee paid particular
attention to cost-of-living indexes, and made recommendations for their
revisions.
The BLS then started its first of many revisions.
The rules used for price collection were changed and procedures
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5
used in the calculation of the index revised which would modify the
weights used to combine cities of different populations.
New goods were
added, and food indexes back to March 1919 were constructed on the new
basis.
Also, the BLS adopted the principle of imputation, that is,
ascribed to a sample item that could not be priced, the price change for
groups of items presumed to have price movements similar to the sample
item.
Lastly, the base period was shifted to 1938-39.
The 1953 Revision
The end of World War II showed a need to revise the CPI.
In
1949, the high prices of goods caused by World War II had come back down
after the lifting of the price controls and Congress therefore, approved
a three-year program to modernize the index.
The major change of this
revision was to add the purchase of a home in the weighting pattern in the
market basket of goods.
The 1964 Revision
It was soon evident that the index weights should be revised every
decade.
A lot of changes had occurred in the composition of the urban
population, in the kinds of goods and services now available to consumers,
and in the net income of urban workers.
These changes dramatically alter
the consumer expenditure patterns upon which the CPI is based.
Again, a
new market basket and new weights were computed to reflect the new distri­
bution of consumer’s expenditures.
Three other changes rose the popula­
tion coverage for the calculation of the expenditure weights to 45 percent.
The sample of retail stores was also revised and expanded.
For the first
time, probability sampling techniques were used to select items for pricing.
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^
6
A system for measuring sampling error was also developed, and price
collection methods were improved.
The 1978 Revision
The most recent revision to the CPI occurred in 1978.
Besides
Updating the weights assigned to various spending categories, the sample
"of items priced and modernizing the statistical methods employed in the
CPI, the biggest change in the 1978 revision was the new Consumer Price
Index for all-urban consumers.
The previous index represented only wage
earners and clerical workers and therefore was, statistically accurately
speaking, appropriate only for that group.
The CPI needed.a more compre­
hensive .coverage to measure inflation and guide monetary and fiscal pplicy
for the„.nation as a whole.
The result was to increase the population
coverage from 45 percent to 80 percent.
The other major change in this revision is the way pricing agents
now price the different market basket items.
’disaggregation* is now used.
An improved method called
He is not now handicapped by such a des­
criptive definition of the item he is trying to find and price.
of
Instead
"Vitamin D, Grade A Homogenized milk in half-gallon containers" it is
now "whole fresh milk."
Future Revisions
Of course the 1978 revision of the CPI will certainly not be the
last.
With on-going research and analysis the BLS will continue to update
and revise the CPI.
Between the 1978 revision and the next major revision,
the BLS will conduct on-going Consumer Expenditure Surveys and Point-ofPurchase Survey programs.
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The reasons for the continuing Consumer Expenditure Surveys is
because of the lag time that results from the length and costs assoc­
iated with the large amount of surveys required for a major revision.
An example of this was that although more than $50 million was spent on
the 1978 revision, the CPI contained base year weights which were five
years old at its first release.
Therefore, smaller, continuing Consumer
Expenditure Surveys are now used to reduce the lag, to eliminate periodic
start-up costs, to increase the overall timeliness and efficiency of
future CPI revisions, and, at the same time, to report current data on
consumer buying patterns.
Another important change to how the total CPI is devised is a
continuing point-of-purchase survey.
These will insure that current and
future CPI’s properly reflect the market place on a continuing basis.
One-fifth of the 85 Primary Sampling Units in the index outlet sample
each year will be researched using these point-of-purchase surveys.
From
these updated surveys, a new outlet sample for each pricing area covered
could be selected.
Thus, over a five-year period, the entire CPI outlet
sample could be revised completely.
The point-of-purchase approach to
"
updating the CPI outlet sample shows a big step forward in CPI design.
The latest change to the Consumer Price Index was recently announced
in the news on October 27, 1981.
The Bureau said that it will reduce the
weight given to mortgage interest rates and house prices.
Under this new
formula, the housing component of the CPI will be changed to the cost of
renting housing, rather than buying it.
This change will of course pro­
duce a slower rate of inflation because this will lower the amount of money
used in calculating the weight for the housing item of the CPI, thus, lower­
ing the entire CPI index.
But at the same time, the lower rate of inflation
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8
will yield smaller cost-of-living raises for Americans whose pay is
tied with the CPI index.
This change will go into effect in 1983.
At any rate, the CPI should be updated more often than its 10-to12 year cycle.
But because of the ever-increasing costs, (the 1950-52
revision took three years and cost $4 million; the 1960-64 revision took
five years and cost $6.5 million; the 1978 revision took eight years and
cost $56 million), the update cycle probably will not be shortened.
Also,
because the length of time to complete a revision seems to be almost doubl-'
ing, it is 'doubtful that the revision cycle would be shortened.
Updated
changes such.as the one like the housing component, are probably the type
of change that one can look forward to in the coming years.
i.
What is the Consumer Price Index?
r
The Çpnsumer Price Index is a weighted aggregative index
number with 'fixed* or 'constant' annual weights, or it
often is referred to as a 'market basket' index.
Thus in
the Consumer Price Index the procedure is to measure price
change by repricing at regular time intervals and comparing
i
aggregate costs of the goods and services bought by consumers
in a selected base period.
The quantities of these goods and
services are kept constant except at times of weight revisions.
Since new weights are introduced without affecting the index
level, any change in aggregate costs is due to price change.^
The quantities represent not only those items actually priced for the
index but also consumption of related items for which prices are not
obtained, so that the total cost of the market basket represents total
consumer spending for goods and services.
^U.S., Department of Labor, Bureau of Labor Statistics Handbook
of Methods, 1974, p. 88.
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Therefore, the CPI compares the cost of this market basket of
goods and services of the current year with that of the cost of the market
basket one year ago, five years ago, etc.
However, there is usually one
year in which each succeeding year is compared to, this year is called
the base period.
The base period for the current CPI is 1967.
For
example, saÿ, that in 1967 the market basket would have cost $100.
1977 the same market basket cost $150.
In
This would mean that the same
goods and services that could have been bought for $100 in 1967, now cost
$150 in 1977. '
The Consumer Price Index is often referred to as a ’cost-ofliving index.’ That is a false representation of the index.
price index.
The CPI measures only changes in prices.
It is a
It says nothing
about changes in the kinds and amounts of goods and services bought or
the total amount spent for living, or the differences in living costs in
different places.
The CPI is based on the purchase of the same goods
and services month after month.
It does not take into account that con­
sumers vary their buying behavior.
They do not purchase the same goods
and services every time they shop.
They may substitute one item for
another, because it may be lower in price or give the same utility
(satisfaction) as the item actually priced for the index.
not take this type of behavior into account.
The CPI does
For that reason it is called
a price index and not a cost-of-living index.
There are also other differences between a price index and a true
cost-of-living index.
For instance, the CPI does not include income and
social security taxes, since, unlike sales taxes, these costs are not
a-sociated directly with retail prices of specific goods and services.
A true cost-of-living index would account for all taxes.
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10
The BLS has done a few studies on how a cost-of-living index
might perform as a price index.
The studies found and compared an
average of one-tenth of an index point per year between a fixed-weight
index such as the CPI and other indexes that adjust the market basket for
substitution (a cost-of-living index). These differences would be minimal
in stable ecônomic periods.
However, during up and down movements in the
economy, like we are going through now, these differences could be very
significant.
The Three Basic Elements of the CPI
The three basic elements of the CPI are;
people buy, (2)
(1)
determining where they buy, and (3)
Determining what
improving the
statistical, techniques.
The Consumer Expenditure Survey
The first basic element of the CPI determines what people buy
and in turn provides a firm statistical basis for the selection and
weighting of the items in the market basket
the Consumer Expenditure Survey.
This basic element is called
The Bureau of Labor Statistics developed
the survey, while the Census Bureau actually conducts the household sample
and does the interviews.
1972 and 1974.
The most recent survey was undertaken between
The following table clearly indicates how the weighting
pattern has changed over the years.
The Point-of-Purchase Survey
The second basic element of the Consumer Price Index is the "Pointof-Purchase' survey.
This survey was an innovation of the 1978 revision
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11
Table 1
Changes in the Weighting Pattern Over the Years
Major Group
Wage Earners & Clerical Workers All-Urban
Consumers
1935-39^ 1953^ 1963^ 1972-73^ 1972-733
Food and alcoholic .
beverages
35.4
32.2
25.2
20.4
18.8
Housing
33.7
33.6
34.9
39.8
42.9
Apparel
11.0
39.4
10.6
7.0
7.0
Transportation -•
8.1
11.3
14.0
19.8
17.0
Medical care
4.1
4.8
5.7
4.2
4.6
Entertainment
2.8
4.3
3.9
4.3
4.5
Personal care
2.5
2.1
2.8
1.8
1.7
Other goods and services
2.4
2.7
2.9
2.7
2.8
Relative importance for the survey period 1934-36 (updated
for price change).
2
Relative importance for the survey period 1947-49 (updated
for price change).
3
Relative importance for the survey period 1972-73. Revised
indexes which require expenditure weights updated for price change
between the survey period and the link dates will differ from those
shown.
SOURCE: U.S., Department of Labor, Bureau of Labor Statistics Handbook
of Methods, 1974.
and will be continued in all future revisions.
greater statistical reliability.
This survey provides
The biggest problems with the old
method was that the samples were not sceintifically selected and would
deteriorate over time.
In the previous index, although areas and types
of outlets were selected with probability methods, the outlets themselves
were not.
Therefore, the Point-of-Purchase survey was developed.
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12
The Point-of-Purchase survey is conducted to select for
each index population a representative sample of retail
stores, mail houses, bowling alleys, doctor’s offices,
and other places where goods and services are bought.
In
contrast to the previous approach, the survey provided for
the selection of the CPI outlets based on information
obtained directly from consumers about where they make
their purchases.
It also provides the only known technique
for associating market basket items with outlets frequented
by specific population groups, such as urban wage earners
and clerical workers and all-urban consumers.
2
'
Improved Statistical Methods
The final element in the CPI are the statistical methods used
to calculate the index.
At each revision and in between these revisions
the statistical methods used are improved.
These improvements are vital
because each new statistical method could have a very substantial impact
inincome payments because of the vast use of the CPI
as an escalator.
One example is that during the 1964 revision about 48 percent of the items
priced every month rose to 53 percent in the 1978 revision.
The statisti­
cians say that the total items priced monthly could be effectively increased
to about 85 percent.
is highly unlikely.
However, because of the additional costs this increase
Another measurement that has been improved are the
time lags in the data.
The use of quarterly or bimonthly instead of
monthly pricing introduces a time lag into the index.
lagged behind the reference month by 22 days.
The 1964 CPI
The 1978 index lagged
2
U.S., Department of Labor, Bureau of Labor Statistics, The
Consumer Price Index: Concepts and Content over the Years, p. 9.
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13
behind 11 days when the prices were collected every two months instead
of every three.
If the total items priced went up to 85 percent the time
lag could be reduced to six days.
This time lag in the data must be
constantly looked after because of the use of the CPI as a deflator in
other government indexes.
Calculation Procedures
As stated before the CPI is a time series.
It is a weighted
average of price changes for a market basket of goods and services,
expressed as an average price and compared to a reference base of 100.
The index measures changes as they occur, but it is not adjusted for
seasonal variation.
In the absence of major weight revisions, and ignoring
the problems of sampling, the index formula is most simply
expressed as:
'
i:o
-
X
100
This is the customary, over-simplified way of writing the
price index to show that the q’s are held constant between
. .
3
major revisions.
In the above formula:
q, is the summation of the yearly quantities bought in a
weight based period for a bundle of goods to be repre­
sented by the specific item priced
p^ and p^ are the average prices for the goods and services
selected for pricing,
i is the current month
o is the reference base period of 1967.
3
U.S., Department of Labor, The Bureau of Labor Statistics Hand­
book of Methods, p. 102.
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14
Illustrative Example
The following illustrative example (see Table II) should help
to show and get a better feel for what happens when the CPI is calculated.
Average price changes from the previous pricing period to the current
month are expressed as ratios for each item.
Next, the price changes for
the various goods and services are combined, using weighting factors based
on the importance of the item in consumer spending.
This combined import­
ance is called the cost weight of the market basket item.
■ ■■
Table II
How the CPI is Calculated
September
Ratio
October s- Cost
September Weight
October
October
Cost Weight
(Sept. X ratio) Price
Sample
Item
September
Price
Pork chops
$0.75
1.03
$15.00
$15.45
$0.7725
Ham
$ .80
1.025
$ 8.00
$ 8.20
$ .82
Bacon
$1.00
1.02
$10.00
$10.20
$1.02
SOURCE: U, S., Department of Labor, Bureau of Labor Statistics Handbook
of Methods, 1974.
The average change in pork prices is computed by comparing the
sum of the cost weights in October with the comparable sum for September,
as follows:
October cost weight............. $33.85 ^
September cost weight ........... $33.00
_
102.6
This means that pork prices in October were 2.6 percent higher than pork
prices in September.
To figure out the final number for the CPI all the cost weights
for each item are added together for each area.
These totals for each
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15
area are then added together, weighting each area total according to the
proportion of the total wage-earner and clerical-worker population which
it represents i,n the index to come up with the United States' total.
Finally, published index values are computed by dividing the cost weight
for a particular series by the average cost weight of the standard
reference bass period of 1957, and multiplying the result by 100.
Problems in Constructing a CPI
Therè are a few major problems that are encountered when construct­
ing the Consigner Price Index which should be
examined.These should be
kept in mind when using the Index.
Three major problems in constructing a new CPI are:
Who should
make up the index population; dealing with quality shanges in the goods
and services surveyed; and, the seasonal adjustment to the index.
The problem of just who should make up the population of the
index has always plagued the BLS.
Historically, the index has been
oriented toward the urban wage earner, who was classified as 'low income.'
However, since World War II the shift of these urban wage earners has
been to the suburban areas of the cities and
their incomes have risento
that of the middle-income urban population. Also, the shift toward a
service economy has helped raise the incomes.
This shift therefore
raised serious questions about the population coverage of the index.
In
1974, the Bureau of Labor Statistics decided to expand the coverage of the
index to all urban consumers.
This decision led to a spirited debate
among many union leaders and Congress, because of the high rate of
inflation at the time and the great increase in the use ofthe index as
an escalator formany different types of income payments.
After much
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16
discussion it was decided to publish the revised index of all urban
consumers.
The second major problem in compiling a price index is dealing
withquality changes
in goods and services.
There is no entirely satis­
factory solution to the problem because the market basket must be constant,
while products and consumption patterns are continually changing.
The Consumer Price Index has achieved a partial solution
to the problem.
The BLS observes the cost of both the old
and .the newitem when both are available in the market at the
same time.
The difference between such values is assumed to
be a measure of the quality change, and that amount is adjusted
out of the price of the new item.
With many goods and services,
however, both the old and the new (or the old and the improved)
are not available at the same time in the market.
In such
cases, an attempt is made to determine the difference in
manufacturers' costs.
This difference is then considered a
measure of the quality change and is adjusted out of the new
price.
Quality changes, however, continue to require a great
4
deal of judgement on the part of the statistician.
For example, automobile prices must be adjusted yearly to make sure that
the new quality inqprovements are not measured as price increases.
And, of
course, it is always difficult to tell which features are new and which
are not.
The third major problem, that of adjusting the index for seasonal
patterns, is also a bit more difficult than the first.
Studies have
shown that much of the seasonal variation takes place in prices of food.
William H. Wallace and William E. Cullison, Measuring Price
Changes: A Study of Price Indexes, Fourth Edition, April 1979, Federal
Reserve Bank of Richmond, p. 40.
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17
apparel, and private transportation, and that the all-items index is
affected slightly by seasonal movement.
By seasonal it is meant that
these purchase patterns depend on what time of year it is and these
abnormal patterns distort the calculation of the CPI.
roust be adjusted out.
Therefore, these
The method used by the BLS is the ratio-to-moving-
average procedure with some modification, and with a means for continuously
adjusting the seasonal factors for changes in the underlying seasonal
pattern.
Limitations of the CPI
Even though the Consumer Price Index involves many complicated
formulas and much statistical analysis there are still a few limitations
which should be discussed.
The CPI is not an exact measure of price change.
V ■■
is sampling errors.
One limitation
These errors are caused and are inherent in the
final index number calculated because actual retail purchases made by
consumers cannot be possibly recorded.
errors affect the accuracy of the index.
Therefore, estimates or sampling
The accuracy could be increased
if larger samples were used but the costs of this prohibit it.
Also,
statisticians say that the error in index is not very much to affect
what the index is used for.
Another kind of error occurs because the people who give out
information requested by the Bureau sometimes do not report it accurately.
The greatest precautions are taken to avoid errors in pricing, because
these errors would affect the index most seriously.
Also, the commodity
specialists and clerks who process the data are well trained to watch for
unusual deviations in prices which might be due to errors in reporting.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
18
The CPI represents the average movement of prices for urban
consumers.
Some families may find their outlays changing because of
changes in factors other than prices, such as family composition.
The
index measures only the change in prices and none of the other factors
which affect family living expenses.
Another limitation which could affect the index are quality changes
which affect the quoted price of the good and therefore must be taken out
before that price is used in calculation of the index.
However, this
cannot always be done and therefore some residual effects do affect the
movement of the CPI either upward or downward from time to time.
Uses of the CPI— What the Worker-Consumer Should Know
Now that the CPI has been discussed, the real concern of the
consumer is 'how does the CPI affect me?’
on the street really cares about.
This is what the average person
This then is the next topic.
The first use of the CPI that will be discussed is the one seen
and heard on the nightly news report.
an indicator of inflation.
Inflation!
This is that the CPI is used as
When one hears on the news that
the CPI has risen another percentage point or two, what exactly is
happening?
A price rise means a decline in the quantity of goods and
services that a given amount of money will buy.
Thus, measures of price
change are also measures of change in the value of the dollar.
The
purchasing power of one’s dollar can be easily calculated when you hear
or read what the current CPI is.
Let’s say for example, while watching
the evening news, one hears that the CPI is 110.5.
is just the reciprocal of the CPI:
equals
x 100.
The purbhasing power
purchasing power of the dollar ($pp)
Here we have $pp = '£iq~5 ^ 100 = $.90.
Therefore, the
dollar is worth only 90 cents.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
19
Also of interest to many consumer-Investors are comparisons
of different year CPIs.
The Bureau of Labor Statistics pub­
lishes a series showing the current purchasing power of the
dollar., based on the 1967 'allitems’ consumer price index
for all urban consumers and the producer price index for
finished goods.
For comparisons with another base period
in which the purchasing power is $1.00, the appropriate
price index for the base period is divided by the index for
the date to be compared.For example,
the 1972 consumer
price index of 125.3 is divided by the 1978 CPI of 195.4 to
obtain the 1978 purchasing power of the 1972 dollar which
equals $.64.
The Current CPI is and its
Purchasing Power Is Therefore
A secopd use of the Consumer Price Index is as a deflator of
other economic series.
This means it used to adjust other series for
price changes and then to put these Indexes into inflation-free dollars.
Some of these other series are:
retail sales; hourly and weekly earn­
ings; and some personal consumption expenditures used to calculate the
Gross National Product (GNP).
A third major use of the CPI affects millions of Americans and
the numbers are increasing everyday.
payments.
This use is to escalate Income
Collective bargaining agreements are now a common day term.
From professional athletes to employees of small manufacturers, all have
these types of contracts and fight hard to keep them, even if it means
striking.
More than 10 million workers are now covered by collective
bargaining agreements which provide for increases in wage rates based on
^Elizabeth W. Angle, Keys for Business Forecasting, Fifth Edition.
April 1980, Federal Reserve Bank of Richmond, p. 21.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
20
increases in the CPI.
Belatedly the CPI is used as a guide in drafting
new contracts and in wage negotiations.
Also, Social Security bene­
ficiaries, retired military and Federal Civil Service employees and
survivors, and food stamp recipients all have their payments affected
by the up and down movement of the Consumer Price Index.
In addition,
escalator clauses in rental, royalty, and child support agreements auto­
matically increase payments to an underdetermined number of people.
Overall, approximately one-half of the population is affected by the CPI.
In fact, a .1 percent increase in the index can cause about a $100 million
increase in payments in these social programs.
As can be seen above the Consumer
Price Index affects a large
number of people, young and old, no matter what kind of job and of course,
every time we go to the store.
By having some knowledge of the CPI and
how it works can help the average consumer understand why the dollar
dowsn*t stretch as far any more.
The Consumer Price Index measures
price changes over time, but
they do not show whether prices or living costs are higher or lower in
one area compared to another area.
This is where the American Chamber
of Commerce Researchers Association (ACCRA) Index is used, the next topic.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
CHAPTER III
THE ACCRA INTER-CITY COST-OF-LIVING INDEX
Development of the ACCRA Index
A measurement of living cost differences among communities
throughout the nation was first suggested to the membership
of the'American Chamber of Commerce Researchers Association
(ACCRA) at its 1966 annual conference.^
This need for such an index was apparent then as now, because the Consumer
Price Index does not measure this type need.
Therefore, this small group
of community.leaders researched and developed what has now been named the
ACCRA Inter-City Cost-of-Living Index.
Their success has been rewarded
by sidespread and still-growing private and public sector acceptance of
the ACCRA Index.
Initial testing which showed the usefulness of the project began
in the second quarter of 1967, when chambers of commerce across the
country were asked to participate.
They collected price data at a
specific time for a variety of consumer goods.
The researchers then
evaluated the data and made some modifications to ensure the accuracy
in reporting the results and then in the first quarter of 1968 published
the first intercity cost-of-living index.
Price Reports and Index Reports
£
ACCRA Inter-City Cost-of-Living Index Instruction Manual for
Participating Cities, (American Chamber of Commerce Researchers Associa­
tion, Revised, January 1979), p. IV.
21
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
.
/
22
have been published quarterly since then.
The Price Report lists all
prices for each item in each component index for all reporting cities.
The Inter-City Index Reports lists All-Items Index and the six component
indexes for all reporting cities.
Since its inception, the ACCRA Index has been governed by a
committee whith is responsible for ensuring the accuracy and reliability
of the Index.
Changes to the procedures of the Index have been minor
over the years.
The most important revisions occurred in January 1979,
when the committee updated weights in response to new data on consumer
expenditure patterns, broadened the Index's coverage of expenditure com­
ponents , and adopted refinements in the procedures for calculating the
Index.
Constant watch is kept on the changing market conditions to
ensure that the Index reliably shows intercity differences in cost of
living.
Computation of a ACCRA Cost-of-Living Index
The American Chamber of Commerce Researchers Association
has one purpose in producing the ACCRA Cost-df-Living Index;
to obtain, through procedures which can be followed practic­
ally and rigorously by chamber of commerce staff, the best
possible measurement of relative cost-of-living differences
among cities.
Prices for items forming the basis of this
in adherence to standard specifications, and then converted
to index form through accepted statistical procedures, offer
a useful and reasonably accurate measurement of intercity
cost-of-living differences.
As consumers we buy a limitless array of goods and services, so
any index that is put together cannot possibly cover all these purchases.
^Ibid, p. 1.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
23
The approach used by the ACCRA researches in constructing their index is
to divide consumer expenditures into categories, and then to select items
which represent those categories.
The items used are thus, representa­
tive of entire categories of consumer spending, and the assumption is that
intercity differences in prices for the items priced reflect the differ­
ences for the,, categories they represent.
Therefore, in the ACCRA Index
consumer expenditures are divided into six major categories;
,
grocery items,
housing, utilities, transportation, health care, and miscellaneous goods
and serviced. ' Each of these major categories is then composed of sub­
categories, each of which is represented by one or more items priced for
the Index.
The ACCRA Index presents data for an All-Items Index and six
component indexes.
Component indexes are based on individual item prices;
the number of items in a component index ranges from two in the Housing
Index to 25 in the Grocery Items Index.
A copy of an ACCRA Price Report is shown next which shows the six
major categories and the subcategories of each major category.
The next
three pages show Table III, Table IV and Table V of a typical Price Report. ■
A note should be added here stating that no attempt is made to determine
the extent to which consumers purchase items in the Index.
^
The items are
selected to show intercity price differentials for the categories they
represent.
What is measured in the distribution of consumer expenditures
among the categories used in the Index.
It doesn't do the ACCRA researchers
any good to determine that the price for item X in a given city differs
from the nationwide price for item X by a certain percentage; they must
calculate what proportion of consumer expenditures are spent in the cate­
gory item X represents to determine that category's importance, or weight
in the Index.
The ACCRA committee has used the 1972-73 Consumer Expenditure
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
24
Survey data to help them figure out their weights.
The weights were
selected to be appropriate for middle-management executive family.
An example of an Index Report is shown here.
As stated above The
Inter-City Index Report lists an All-Items Index and the six major cate­
gories and the calculated weights for each one.
See Table III
Table III
ACCRA City Composite Index First Quarter, 1979
Weights
.24
.25
.12
.15
.08
.16
City
All
Items
City.
Index
Grocery
Items
Housing
Utilities
Trans­
portation
Health
Care
Misc.
Goods
and
Services
City A
104.5.
104.1
105.0
108.3
104.1
97.0
105.6
City B
117.0
112.2
125.4
110.0
113.0
125.1
116.0
City C
98.0
102.3
104.9
86.7
93.3
75.7
105.0
For the All-Items Index and for each of the component indexes, the base
each quarter equals 100, which is the average for all reporting cities.
When the different chambers across the country were first computing
the Index, they fully realized that state and local income, ad valorem,
and sales taxes are a part of the cost of living.
Also, they knew that
the tax burden varies significantly not only among states, but also among
cities within each state.
Due to the multiplicity of local taxes, rate
structures, taxing jurisdictions, and assessment procedures, however, no
adequate method exists with which to compare total tax burdens.
Therefore,
when the ACCRA Index was first computed, the decision was made to exclude
from the price reports all taxes except those which are an integral part
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
25
of item prices— for example, excise taxes on tobacco, telephone service,
gasoline, and liquor.
The position was taken that a cost of living index
which expressly excludes taxes not imposed as part of the base cost of an
item provides a useful indicator of living cost differences among cities.
A part of the Price Report that ACCRA puts out can be seen in the
following pages.
It is really quite easily interrupted.
Table IV lists the
prices of the 25 grocery items and Table V lists the prices of
the 19 non-grocery commodities and services.
The specifica­
tions listed for the grocery items are basically self-explanatory.
The specifications listed for all non-grocery items are presented
to the user only as a guide, since the price computations are
based on extensive research within city and in accordance with
8
explicit specifications and procedural instructions.
You can subscribe to the Price Report and the Index Report to get the
latest prices end trends for yourself and business, so long as the users
of the ACCRA Index are aware of this exclusion.
The ACCRA people of each reporting city have three different ways
they can go out and collect the price data needed.
by telephone, and by pricing in person.
They are;
by letter,
The experience of the researchers
has shown that no one method can be used efficiently for all items, and
that some methods are better than others for particular items or groups of
items.
For example, in the case of the Grocery Items Index, the telephone
is the least efficient method because it is susceptible to the most report­
ing errors.
In this case, the personal pricing has proven to be the most
efficient method.
8
ACCRA Price Report, Inter-City Cost of Living Indicators, Second
Quarter 1980, American Chamber of Commerce Researchers Association, p. i.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
26
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28
What the ACCRA. Index Tells Us
By measuring price levels of specific commodities and services
which represent broad categories of consumer expenditures, and
by weighting the relative prices of these items to reflect the
spending patterns typical of a middle-management executive
family, the Index shows relative price levels in participating
9
cities at a given point in tiem.
As stated before, the Index Report shows each city’s relative
cost of living for the six major components and is expressed as a per­
centage of the average for all reporting cities in that quarter.
eachcity's overall cost of living is shown
Also,
in the All-Items Index as a
percentage of the overall cost of livingaverage for all reporting
cities.
As in the Cqnsumer Price Index, the Index is based on sampling techniques
and because of this the Index numbers are approximations rather than
entirely accurate ones of the relative living costs.
Therefore, it is
reasonable to assume that inter-city differentials of less than three
index points do not represent statistically significant differences in
living costs.
What the ACCRA Index Does Not Tell Us
As described in the last section, sampling errors and non-sampling
errors for example, the possibility that a miscalculation of average price
for a particular item may go undetected despite the several data checks,
cause the Index not to report actual percentage differences among cities.
ACCRA Inter-City Cost-of-Living Index Instruction Manual for
Participating Cities, (American Chamber of Commerce Researchers Assoc­
iation, Revised, January 1979), p. 35.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
29
Therefore, one cannot subtract one city’s index number from another and
conclude that the price differential between the two is exactly the
result found*
Small differences between cities do not represent signi­
ficant differences in living costs, while larger differences do show
some significant value.
For example, if City A's All-Items Index is 101.1 and City B's
is 102.3, one cannot conclude either that there is a significant differ­
ence or even that living costs are higher in City B than in City A:
the
difference is-BO small that, if costs of living could be more a-curately
determined. City B might be the less expensive of the two.
clude that any differences are scant.
One can con­
On the other hand, suppose that
City C has an All-Item Index of 100.0 and City D’s All-Item Index is 120.0,
Clearly there is a significant and substantial cost of living differential—
but that differential is not necessarily 20 percent, and should not be so
represented.
A second misrepresentation of the Index is to use it as a time
series.
The ACCRA Index does not measure changes over time.
Each quarterly
report is separate and data from different quarters cannot be compared.
One reason is because the number and mix of the cities in the report
changes from one quarter to the next.
If the listing of participating
cities were always the same, and if those cities accurately represented
the entire United States, then one could construct a time series.
Another
reason is that some cities do not submit a completed report each quarter
and therefore are dropped for that quarter.
Lastly, the reason the ACCRA
Index is not a time series, is because the price input may change because
there have been changes in the specifications in the way items are reported
and weights are calculated and better reporting procedures are established
with experience.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
30
The ACCRA Index Versus the Consumer Price Index
The Atoerican Chamber of Commerce Researchers Association InterCity Cost-of-Living Index put together by cities such as Great Falls and
the Consumer Price Index produced by the Bureau of Labor Statistics are
conceptually distinct.
There really isn't comparison between the two.
The ACCRA Index measures living cost differences among cities
at a given point in time.
The CPI, produced for the United
States- and for each of 28 Standard Metropolitan Statistical
Areas, measures price changes over time within each area, but
provides no comparisons among areas in terms of actual prices.
The ACCRA Index provides estimates of living cost differen­
tials among areas, but presents no information about price
changée over time; the CPI measures inflation over time, but
says nothing about how living costs in different areas compare.
The ACCRA Cost-of-Living Index is unique in providing
comparisons of living costs among a large number of localities
on a continuing and current basis and in focusing solely on
components of expenditures which reflect location differen­
tials.
Using the ACCRA Index
The ACCRA Index allows one to gain an approximate idea of the
relative price levels in participating cities at a given point in time.
Because the Index is constructed using sampling techniques it should be
pointed out, therefore, that the index numbers are approximations rather
than entirely accurate representations of living costs.
Even so, one
can still establish a general degree of difference between living costs
of the cities compared.
This analysis can help families anticipate the
l^Ibid, p. 38.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
31
financial consequences of moves, and it may be especially useful to
the often transferred executive or military family.
The small businessman is also a big user of the index and if he
is not he can profit from doing so.
He can compare prices of his goods
with those of other cities, thus enabling him to set his prices accordingly.
Realtors and gas and electric companies can use the index for
regulating their prices based on what other cities are doing.
them bargaining power when they want to raise their prices.
This gives
This index
is used in the same way by the health care and medical profession.
Room
rates and other expenses can be compared and raised accordingly.
At this point it should be reemphasized that each price that is
reported in the Price Report is subject to errors.
Prices are valid only
to the extent that the statistical methods used are valid.
Also, errors
in recording thé price of each item, especially food, can lead to reporting
errors even with the many double checks.
While glancing at the copy of the Price Report one may notice
that there are some large differences in prices of certain items in the
same geographic area.
An example would be the price of bread inthe
reporting cities of California.
Talking with the people who work at the
Great Falls Chamber of Commerce to ask why these perplexing anomalies
occur said that reporting errors could be one cause, although they said
this happens very infrequently.
The main reason they said is that sales
prices may be used to report the price.
Say for example, a store surveyed
in Great Falls is not having a sale on bread and the store surveyed in
Helena does, that sale price may be used as the normal price.
This can
really distort the 'real' cost difference, but is perfectly legal accord­
ing to the ACCRA price recording rules.
The lowest price found in the
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
32
city for that particular item or service can be used.
Therefore, this
seems to be the major reason for the large differences in price reporting
between citieS for certain items.
Therefore, one should be extremely cautious when comparing prices
between cities.
If you move from one city to another and expect cheaper
prices for certain items you may not find that to be true.
There is great
competition among the different chambers to report the lowest possible
price to make their city appear better to live in.
As a noté to Great Falls* consumers, the Great Falls Tribune
published the latest ACCRA report in its November 30, 1981 edition.
On
the All-Item's Index, which is based on 100 as the national average. Great
Falls lost its distinction as Montana's least expensive city.
Havre is
now the lowest ranking with 99.2, while Billings was 100 even and Great
Falls 101.6.
Helena was the most expensive, at 106.
In comparison. New York City stands at 137.4; San Diego 119.3;
Houston 109.9; and Phoenix 108.3.
According to the ACCRA averages. Great Falls was the lowest in
the state in utilities, transportation and health care but was listed as
next to the top in the state in the housing category.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
CHAPTER IV
RESULTS AND FINDINGS
Restatement of the Problem
This paper has attempted to give a brief history of, an explana­
tion of, and uses of the Consumer Price Index and the American Chamber
of Commerce Researchers Association's Index.
The basic argument was that
the average consumer really doesn't understand what
the CPI is, even
though it probably affects his take-home pay because it is in his union
contract.
Therefore, this paper has drawn together many reports, articles,
and papers on the CPI to help explain this everyday-heard concept.
In the
same way it was hoped to bring to light a new topicmostly unheard of to
the average consumer; that is, the ACCRA Index.
It is hoped that this paper has brought together the different
subject areas of the CPI and ACCRA Index so that it was explained in the
consumer's language.
Now that inflation is becoming more and more
important to the American consumer, he wants to know more of why inflation
is so high, how it is measured, what affect government policies are
having on it and how it all affects his paycheck each week.
Therefore,
it is with high hopes that this paper has provided some insight into the
CPI and ACCRA Index.
Additional Research
This paper has primarily used secondary data in the research of it.
It has not attempted to change how the CPI or ACCRA Index are calculated
33
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
34
or make any other attempt to change them.
Its sole purpose is to put
into layman* s language an explanation of the CPI and ACCRA Index.
For additional research it is recommended that this paper can
be used as a stepping stone for further education of the American con­
sumer in our economic system.
It has been shown that the average American
consumer doeë hot understand how our economic system works and therefore
should be further educated.
This paper can help toward that end.
Also, this paper has not attempted to provide an in-depth report
on the CPI. 'It is recommended that the more involved student or business­
man pursue more advanced research.
However, this paper can provide
valuable background material for that additional research.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
CHAPTER V
CONCLUSIONS
The Consumer Price Index or 'cost-of-living index' is heard
almost everyday on the news or read in the newspaper.
It is used as the
principal measure of inflation in the U.S. economy, but is rarely under­
stood by the average American consumer.
Developed during World War I by
the Shipbuilding Labor Adjustment Board to arrive at a 'fair wage scale,'
it has gone through four major revisions and Bureau of Labor statisticians
are always trying to improve it.
The latest change to the CPI will
take effect in 1983, when the weight given to mortgage interest rates
and house payments will be reduced, thus lowering the overall rate of
inflation.
Actually, the CPI is not a 'cost-of-living index' but rather
a price index.
It measures only changes in prices of the same market
basket of goods and services month after month.
The CPI does not measure
the differences in living costs in different places.
basic elements to the CPI:
There are three
determining what people buy, measured by the
Consumer Expenditure Survey; determining where they buy, measured by the
Point-of-Purchase survey; and constantly improving the statistical
methods used to calculate the CPI.
To calculate the index prices are
collected for the current year and are then compared to the base period
of 1967 which equals 100 and then expressed as a percentage of the base
period.
When constructing a CPI there are a few problems encountered.
The first is who should make up the index population.
The second is
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36
dealing with quality changes in a product when trying to figure out its
'real' price increase.
Lastly is the seasonal adjustment to the index.
Some of the limitations of the CPI which should be known are that the
CPI is not an exact measure of price change.
Sampling errors, price
reporting errors and quality changes all affect the number that is
calculated as the CPI.
American daily.
The CPI has many uses which affect almost every
As an indicator of inflation the CPI measures the
purchasing power of the dollar.
worth only $190.
A CPI of 110.5 means the dollar is
Also, the CPI is used to escalate income payments in
many union contracts.
Because the CPI does not measure the living cost differences
from one area to another the American Chamber of Commerce Researchers
Association (ACCRA) Index was developed.
six major consumer categories:
Price data are collected for
grocery items, houwing, utilities, trans­
portation, health care, and miscellaneous goods and services.
The ACCRA
Index provides data for each of these categories and a combination of all
these called the All-Items Index.
The index shows relative price levels
in participating cities at a given point in time.
are limitations to the index.
As with the CPI there
It has sampling errors and non-sampling
errors, such as price reporting errors.
Therefore, the index of one
city should not be subtracted from another's index to come up with an
exact percentage difference between the two cities.
Also, it should be
remembered that the ACCRA Index is not a time series as is the CPI.
does not measure changes over time.
It
The ACCRA Index provides estimates
of living cost differences among participating cities, but says nothing
about price changes over time; the CPI measures inflation over time, but
says nothing about living costs in different areas.
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37
The Consumer Price Index and ACCRA Index are two very important
measures of today's economy and should be understood by all American
consumers.
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BIBLIOGRAPHY
ACCRA Inter-City Cost-of-LlvlnR Instruction Manual for Participating
Cities. American Chamber of Commerce Researchers Association.
Revised, January 1979.
ACCRA Price Report Inter-City Cost-of-Llvlng Indicators. American Chamber
of Commerce Researchers Association. Second Quarter 1980.
Angle, Elizabeth W.
April 1980.
Keys for Business Forecasting. Fifth Edition,
Federal Reserve Bank of Virginia.
The Consumer Price Index— What Is It? Jones, Larry D. University of
Kentucky, Department of Agricultural Economics. April, 1974.
The Great Falls Tribune. October 27, 1981.
The Great Falls Tribune. November 30, 1981.
The Wall Street Journal. October 7, 1981.
U.S.
Department of Labor. Bureau of Labor Statistics. The Consumer
Price Index: Concepts and Content Over the Years. Report 517,1979.
U.S.
Department of Labor.
1974.
Bureau of Labor Statistics Handbook of Methods.
Wallace, William H. and Culllson, William E. Measuring Price Changes;
A Study of Price Indexes. Fourth Edition, April 1979. Federal
Reserve Bank of Virginia.
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