The consumer price index measures the amount of money which consumers of a particular class have to pay to get a basket of goods & services at a particular point of time in comparison to what they paid for the same in the base period.
Different classes of people consume different types of commodities & even that same type of commodities are not consumed in the same proportion by different classes of people (for e.g. higher class, middle class, lower class). The general indices do not highlight the effects of change in prices of various commodities consumed by different classes of people on their cost of living.
Methods of Constructing Consumer Price Index
We can construct the consumer price index by any of the following two methods :
(1) Aggregate Expenditure Method or Aggregative Method
(2) Family Budget Method or the Method of Weighted Relatives
Aggregate Expenditure Method:
This method is similar to the Laspeyres’ method of constructing a weighted index. In this method the quantities of various commodities consumed in the base year by a particular class of people are taken as weights.
Where
p1 & p0 are prices of current year & base year respectively.
q0 = quantity consumed in base year.
Family Budget Method
This method is same as the weighted average of price relative method discussed earlier. The formula is as follows:
Where
V = Value weights i.e. p0q0.
Uses of Consumer Price Index Number:
(1) We use this to formulate economic policy and also to measure real earning.
(2) We use this to measure purchasing power of the consumer. The formula is as follows—
(3) We use it in deflating. The process of deflating—
(4) We use it in wage negotiations & wage contracts. It also helps to calculate dearness allowance.