The composition of the market basket is fixed in the base period and is assumed not to change from one period to another.
It is the most widely watched and used measure of the U. For several years, there has been controversy about whether the CPI overstates or understates inflation, how it is measured and whether it is an appropriate proxy for inflation.
Read on to learn more about how the CPI affects investors. The Controversy Originally, the CPI was determined by comparing the price of a fixed basket of goods and services in two different periods.
However, over time, the U. Congress embraced the view that the CPI should reflect changes in the cost to maintain a constant standard of living. Over the years, the methodology used to calculate the CPI has also undergone numerous revisions.
The new methodology takes into account changes in the quality of goods and substitution. Substitution, the change in purchases by consumers in response to price changeschanges the relative weighting of the goods in the basket. The overall result tends to be a lower CPI.
Williams prefers a CPI, or inflation measure, calculated using the original methodology based on a basket of goods having quantities and qualities fixed.
What is immediately apparent is that three different definitions of the CPI are being used. Since these definitions are not operationally equivalent, each method of measuring inflation would lead to different results. Different CPI or Inflation Levels It does appear that the differing means of measuring inflation produce disparate indications of inflation for the same period.
Therefore, a prudent investor may wish to obtain more insight and a better understanding of these disparate views of CPI and inflation measures and the effects they may have on their investment decisions. Implications for Required Return Rates Investors must calculate their total required rate of return RRR on a nominal basis, taking into account the effect of inflation.
The nominal, annual required total return can be approximated as the real required return plus the rate of inflation. For short investment horizons, the approximate method works well. However, for longer investment horizons such as 20 or greater yearsa slightly different method should be used because the approximate method will introduce additional inaccuracy, which will be compounded as the investment horizon increases.
A more accurate estimate of the nominal, annual required total return is calculated as the product of one plus the annual inflation rate and one plus the required annual real rate of return. The results tabulated below clearly show that as the difference between the inflation rate and the real rate of return increases, the difference between the approximated and the accurately determined total required returns increases.The Consumer Price Index is a measure of the prices of a fixed market basket of some consumer goods and services purchased by a 'typical' urban consumer.
The period serves as the base period so analysts can compare other year's changes with this base period.5/5(4).
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Mistakes of the Consumer Price Index(cpi) The Consumer Price Index is a measure of the costs of an altered business wicker bin of around customer products and administrations bought by a . The Census and Statistics Department (C&SD) released today (November 20) the Consumer Price Index (CPI) figures for October According to the Composite CPI, overall consumer prices rose by % in October over the same month a year earlier, remaining virtually unchanged as compared to September An analysis of the flaws in the calculation of the Consumer Price Index.
Inaccuracies of the Consumer Price Index(CPI) The Consumer Price Index is a measure of the prices of a fixed market basket of some consumer goods and services purchased by a “typical” urban consumer.