The Consumer Price Index (CPI) gives data on changes in the prices paid by urban consumers for a representative basket of goods and services. The CPI-basket contains basically all the goods and service consumed in a country - food, gas, medicine, haircuts, transportation, house rent and so on. The composition of the CPI basket is determined by the value of what is consumed in the country - the larger the value of total consumption of a good or service, the larger the weight in the basket. For example, if we spend twice as much on apples as on pears, apples will have twice the weight in the basket. The exact details of the composition of the basket and how the CPI is calculated are complicated and vary somewhat between countries. Here you can see CPI for Germany after the reunification starting at January 1991. This data has 2005 as the reference year. Tins means that the CPI is constructed in such a way that CPI is exactly equal to 100 on average during 2005.
Problems with CPI
To illustrate the problems involved in calculating the CPI we consider phones. If you measure the average price of phones at two points in tune, say one year apart, you may find that the average price has not changed.
However, this is not the whole story since the products on the market will have changed. Typically, the products at the later measurement are more advanced than the products at the first measurement. If you were to compare prices of phones with the same performance, you would probably find that prices have fallen. Without adjusting for changes in performance and quality, you will usually overestimate the rise in the price index.
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