WHAT IS THE CPI?



OVERVIEW OF THE 16TH SERIES CPI

2.1 The 16th series Consumer Price Index, Australia (CPI), consistent with the 13th, 14th and 15th series, has been designed as a general measure of price inflation for the household sector as a whole. The CPI measures changes in the price of a fixed basket of goods and services acquired by consumers in metropolitan private households.


CPI measures price change of a fixed basket of goods and services

2.2 The simplest way of thinking about the CPI is to imagine a basket of goods and services comprising items bought by Australian households. Now imagine the basket is purchased each quarter. As prices change from one quarter to the next, so too will the total price of the basket. The CPI is simply a measure of the changes in the price of this fixed basket as the prices of items in it change.


CPI reference population is all metropolitan private households

2.3 The CPI measures price changes relating to the spending pattern of all metropolitan private households. This group is termed 'the CPI population group', and includes a wide variety of sub–groups such as wage and salary earners, the self–employed, self–funded retirees, age pensioners, and social welfare beneficiaries. The term 'metropolitan' means the six State capital cities, Darwin and Canberra. The current series CPI population group represents about 64% of all Australian private households.

2.4 Ideally the CPI population group should encompass all Australian households, but this is not possible due to the substantial additional resources that would be required to collect prices outside the capital cities. ABS research has shown that, in general, price movements (as distinct from price levels) are similar across regions. An outcome of the 16th series review was that the ABS will continue to explore cost effective options to expand CPI coverage beyond capital cities. However, this must be considered in the context of competing priorities within the ABS work program.


Base period index number is 100.0

2.5 The price of the CPI basket in the index reference base period is expressed as an index by assigning it a value of 100.0 and the prices in other periods are expressed as percentages of the price in the base period. For example, if the price of the basket had increased by 35% since the base period, then the index would be 135.0; similarly, if the price had fallen by 5% since the base period, the index would stand at 95.0. The current index reference base period for the CPI is 1989–90, although some component series have a base period other than 1989–90.


CPI does not measure price levels

2.6 It is important to remember that the CPI measures price movements (i.e. percentage changes) and not actual price levels (dollar amounts). For instance, the index for Breakfast cereals of 161.7 and the index for Bread of 242.9 in the September quarter 2011 does not mean that Bread is more expensive than Breakfast cereals. It simply means that the price of Bread has risen by more than the price of Breakfast cereals since the base period.


Is the CPI a cost of living index?

2.7 The CPI frequently is called a cost–of–living index, but it differs in important ways from a complete cost–of–living measure. Both the CPI and a cost–of–living index measure the changes in prices of goods and services that are purchased by households. The Australian CPI measures the changes in price of a fixed basket of goods and services whereas a cost–of–living index measures the change in the minimum expenditure needed to maintain a certain standard of living.

2.8 In practice, no statistical agencies compile true cost–of–living or purchasing power measures as it is too difficult to do. A cost–of–living index requires access to both price and current household consumption each period as well as an assessment of households' welfare which depends on a variety of physical and social factors that have no connection with prices. As the CPI is intended to measure the overall inflation in prices of goods and services acquired by Australian households, it is sometimes used as a proxy measure of cost–of–living or purchasing power.

2.9 As a single index cannot be expected to adequately fulfill all purposes, and in recognition of the widespread interest in the extent to which the impact of price change varies across different groups in the community, the ABS compiles and publishes Analytical Living Cost Indexes for Selected Australian Household Types (cat. no. 6463.0) and the Pensioner and Beneficiary Living Cost Index (cat. no. 6467.0), specifically designed to measure changes in living costs for selected population sub–groups. They are particularly suited for assessing whether or not the disposable incomes of households have kept pace with price changes. The employee households living cost index is calculated on a similar basis as the CPI prior to the September quarter 1998.

2.10 The most notable difference between these indexes and the CPI is that the living cost indexes include interest charges but do not include new house purchases, while the CPI includes new house purchases but does not include interest charges. Households have been categorised based on the principal source of household income, derived from the 2009–10 Household Expenditure Survey (HES). The four household types in the scope of the HES account for just over 90% of Australian households. The four household types that have been identified as being appropriate for the construction of these indexes, are:

• employee households (i.e. those households whose principal source of income is from wages and salaries);
• age pensioner households (i.e. those households whose principal source of income is the age pension or veterans affairs pension);
• other government transfer recipient households (i.e. those households whose principal source of income is a government pension or benefit other than the age pension or veterans affairs pension) and,
• self–funded retiree households (i.e. those households whose principal source of income is superannuation or property income and where the HES defined reference person is ‘retired’ (not in the labour force and over 55 years of age).

HOW IS THE CPI USED?

The CPI is used as a macroeconomic indicator and for adjusting dollar values

2.11 The CPI affects almost all Australians because of the many ways in which it is used. The two most common uses of the CPI are:

• as a macroeconomic indicator. The CPI, and other index series derived from CPI data, are used by the Government and economists to monitor and evaluate levels of inflation in the Australian economy. Inflation and inflationary expectations play a major role in determining various aspects of Government economic policy, and in the business and investment decisions of private firms and individuals.
• as a means of maintaining dollar values. The value of many types of fixed payments such as social welfare benefits can be reduced over time when prices rise. The CPI is often used to adjust these payments to counter the effects of inflation. This process is referred to as 'indexation'. Indexation arrangements are also often applied to such things as rental agreements, insurance cover and child support payments.

There are many different price indexes available

2.12 Although the CPI is the best known price index, it is but one of many produced by the ABS. Examples of other price indexes include:

• analytical living cost indexes for selected household types;
• producer price indexes;
• labour price indexes;
• house price indexes; and
• chained price indexes produced in conjunction with the Australian national accounts.

2.13 Having determined that a price index is required for a particular application it is important to carefully consider the range of available indexes and select the index which best meets the specific requirement. While the ABS can provide technical and statistical guidance, it does not provide advice on indexation practices and it cannot tell users which index they should use. These are matters for users to determine.

2.14 For a general description of the range of issues that should be taken into account by parties considering an indexation clause see 'Use of Price Indexes in Contracts' at
https://www.abs.gov.au/websitedbs/c311215.nsf/web/Inflation+and+Price+Indexes.


THE CPI BASKET OF GOODS AND SERVICES

CPI basket based on 2009–10 HES data

2.15 The composition of the CPI basket is based on the pattern of household expenditure in the 'weighting base period', which is 2009–10 for the 16th series CPI. Information on the spending habits of Australian households during 2009–10 was obtained from the Household Expenditure Survey (HES) conducted by the ABS. The HES results provide the starting point for selecting the basket of goods and services to be priced for the CPI.


CPI basket includes items representative of all consumer goods and services

2.16 For practical reasons, the basket cannot include every item bought by households but it does include the most significant items. It is not necessary to include all the items people buy since many related items are subject to similar price changes. The idea is to select representative items so that the index reflects price changes for a much wider range of goods and services than is actually priced. Examples of the types of items included in the CPI basket are shown in Appendix 2.

2.17 When determining what items are to be priced for the CPI basket, various factors are taken into consideration. Items:

• must be representative of purchases made by the CPI population group;
• must have prices which can be associated with an identifiable and specific commodity or service (e.g. a 420g can of baked beans, or adult general admission to a club football game);
• are not excluded on the basis of moral or social judgements. For example, some people may regard the use of tobacco or alcohol as socially undesirable, but both are included in the CPI basket because they are significant items of household expenditure and their prices can be accurately measured.

2.18 Income–based taxes, however, are not included in the CPI because they cannot be clearly associated with the purchase or use of a specific good or service.


Deposit and loan facilities

2.19 The Deposit and loans facilities index was introduced into the 15th series Australian CPI in the September quarter 2005. It included both direct and indirect charges of financial institutions. Direct charges include a range of financial transactions used by households including fees for internet transactions, credit card fees, charges for using Automatic Teller Machines (ATMs) and overdraft charges.

2.20 Indirect charges are the interest rate margins calculated on household loans and deposits with financial institutions.

2.21 In the 16th series CPI the deposit and loan facilities (indirect charges) was removed from the headline CPI from the September quarter 2011. The deposit and loan facilities index now includes direct fees and charges only and is named 'Deposit and loan facilities (direct charges)’. A new analytical series, comprising the ‘All groups CPI including deposit and loan facilities (indirect charges)’ is published in the quarterly CPI publication from the September quarter 2011 issue. For further information see Appendix 4 in the Information Paper: Outcome of the 16th Series Australian Consumer Price Index Review, Australia, December 2010 (cat. no. 6469.0).


The CPI groups

2.22 The total basket is divided into 11 major groups, each representing a specific set of commodities:

• Food and non–alcoholic beverages
• Alcohol and tobacco
• Clothing and footwear
• Housing
• Furnishings, household equipment and services
• Health
• Transport
• Communication
• Recreation and culture
• Education
• Insurance and financial services

2.23 These groups are divided in turn into 33 sub–groups, and the sub–groups into 87 expenditure classes. An expenditure class is a grouping of similar items, such as various types of motor vehicles. See Appendix 1 for a full list of groups, sub–groups and expenditure classes and the figure at 4.1 for an illustration of the CPI structure.


THE RELATIVE IMPORTANCE OF CPI ITEMS

2.24 The overall (or All groups) CPI provides a measure of the average rate of price change. In calculating an average measure of this type it is necessary to recognise that some items are more important than others. Price changes for the more important items should have a greater influence on the average rate of price change than price changes for less important items. The relative importance of the goods and services in the CPI is determined by the relative household expenditure on each product. For example, how much more households spend on rent than automotive fuel on average.


CPI weights

2.25 Measures of expenditure on each of the CPI groups, sub–groups and expenditure classes are obtained primarily from the HES. However, some adjustments are made to HES data to account for known instances of underreporting (the most notable being for alcohol and tobacco) and any other anomalies. The adjusted HES data are then used to derive a ‘weight’ for each expenditure class.

2.26 The CPI weights reflect the relative expenditures of the CPI population group as a whole and not those of any particular type or size of household. The weights reflect average expenditure of households and not the expenditure of an 'average household'. The household average weekly expenditure and corresponding 16th series CPI relative weights for the CPI groups are shown in Appendix 1.


Basket is fixed in terms of underlying quantities at the expenditure class

2.27 Although the weights are expressed in terms of expenditure shares, it is not the expenditure shares (where expenditure is given by the product of quantity and price) that are held constant (or fixed) from period to period. What are held constant are the quantities of products underpinning these expenditures such as the number of litres of petrol purchase each period on average by households. Weights are presented in expenditure terms because it is not possible to present quantity weights in a meaningful way e.g. the quantity of health services. The relative expenditure shares of items will change over time in response to changes in relative prices.


Weights below the expenditure class can be varied

2.28 While the implicit quantity weights are held constant at the expenditure class level, the weights of items within an expenditure class (e.g. different types of bread) can be varied between periodic reviews to reflect changed purchasing patterns. Any weight changes are introduced into the CPI in such a way as to not affect the level of the index.


Update of fixed weights

2.29 The average household weekly expenditure and weights for the CPI expenditure classes are updated at six–yearly intervals with the timing generally linked to the availability of HES data. The introduction of new weights resulting from these updates is released as a new CPI series (e.g. the 16th series CPI was introduced in the September quarter 2011 following the release of the 2009–10 HES data). Updating the weights is a key objective of the overall CPI review process. CPI reviews are discussed below (2.40–2.44).


COLLECTING PRICES FOR THE CPI

2.30 The collection of prices in each capital city is largely carried out by trained field staff operating out of the various State and Territory offices of the ABS, while some prices are collected as administrative datasets or special surveys.


CPI goods and services priced at many different types of outlets

2.31 Prices are collected in the kinds of retail outlets and other places where metropolitan households purchase goods and services. This involves collecting prices from many sources such as supermarkets, restaurants, department stores, schools and on–line websites. Prices are collected via personal visit, telephone or internet as appropriate.


CPI based on 100,000 price quotations each quarter

2.32 Prices for items such as rail transport services, electricity and gas supply and telephone services are collected from the authorities concerned. Information on rents is obtained from property management companies and from public housing authorities, In total, around 100,000 separate price quotations are collected each quarter.

2.33 The frequency of price collection by item varies as necessary to obtain reliable price measures. Prices of some items are volatile (i.e. their prices may vary many times each quarter) and for these prices frequent price observations are necessary to estimate a reliable average quarterly price. Each month prices are collected at regular intervals for goods such as petrol, fresh meat, fruit and vegetables, domestic and overseas airline tickets and telephone and internet services.

2.34 For most other items price volatility is not a problem and prices are collected once a quarter. There are a few items where prices are changed at infrequent intervals, for example education services where prices are set once a year. In these cases the frequency of price collection is modified accordingly.


Prices collected are what people actually pay

2.35 The prices used in the CPI are those that any member of the public would have to pay to purchase the specified good or service. Any taxes levied on goods or services (such as the GST) are included in the CPI price. Similarly, prices include any subsidy or assistance provided directly by the government (e.g. Child Care Benefit, Medicare). Sale prices, discount prices and 'specials' are reflected in the CPI so long as the items concerned are of normal quality (i.e. not damaged or shopsoiled), and are offered for sale in reasonable quantities. Any concessions available to particular groups of the population (such as age pensioners) are also taken into account where significant. Where an item is priced over the internet, any delivery or processing charges payable are included in the price.

2.36 To ensure that price movements are representative of the experiences of metropolitan households, the brands and varieties of the goods and services which are priced are generally those which sell in greatest volume.


CHANGES IN QUALITY

2.37 In concept, quality embraces all the attributes of an item which consumers would consider before making a purchase. For example in the case of tinned tomato soup it would include the volume or weight of the contents as well as the concentration and flavour.


Prices adjusted for changes in quality

2.38 As the CPI aims to measure price changes for a fixed basket of goods and services over time, identical or equivalent items must be priced in successive periods. However, products do change; their components or ingredients may change resulting in an improvement or degradation in quality. As the characteristics of products are altered, the statisticians responsible for the price index attempt to separate the effects of a quality change from any underlying price changes so that the CPI measures 'pure' price change. A simple example of quality adjustment is shown below (2.51 to 2.53).


Quality change can be difficult to measure

2.39 The requirement to take account of changes in quality, to ensure that the index reflects only pure price change, often poses difficult measurement problems and in some cases is impossible in practice. For example, while it is fairly easy to monitor changes in rail or bus ticket prices, it is difficult to attach a dollar value to changes in the quality (e.g. frequency or punctuality of the service).


PERIODIC REVIEWS OF THE CPI

CPI reviewed at six–yearly intervals

2.40 Like any other long–standing and important statistical series, the CPI is reviewed from time to time to ensure that it continues to meet community needs. The ABS undertakes these reviews at six–yearly intervals with timing generally (though not necessarily) linked to the availability of results from the HES.

2.41 An important objective of these reviews is to update item weights to reflect changes in the range of available goods and services and changes in household spending patterns. They also provide an opportunity to reassess the scope and coverage of the index and other methodological issues.

2.42 Following these reviews, the new CPI series is linked to the old to form a continuous series. This linking is carried out in such a way that the resulting continuous series reflects only pure price change and not differences in the cost of the old and new baskets.

2.43 The index reference base period for the CPI is also updated, but at less frequent intervals. Changes in reference base periods have no effect (other than rounding) on percentage changes, which are calculated from the index numbers.


Major review conducted in 2010

2.44 The last significant review of the CPI was conducted in 2010, prior to the introduction of the 16th series from the September quarter 2011. Major outcomes of the review were to retain the principal purpose of the CPI as a general measure of household inflation, to remove the indirectly measured component of the Deposit and loan facilities index from the headline CPI and to include a range of additional analytical measures including All groups CPI, seasonally adjusted. For more information see Information Paper: Outcome of the 16th Series Australian Consumer Price Index Review, Australia, December 2010 (cat. no. 6469.0).

2.45 Prior to the 16th series review, the previous major review of the CPI was the 13th series review conducted during 1997 and 1998 introduced in respect of the September quarter 1998. A major outcome of that review was the decision that the CPI would change from a measure of the change in living costs of employee households to a general measure of price inflation for the household sector. Consequently the population coverage was expanded from wage and salary earner households to include all metropolitan households.


HOW DOES THE CPI RELATE TO ME?

CPI unlikely to reflect the price experience of individual households

2.46 The CPI is designed to measure changes in retail prices experienced by metropolitan private households in aggregate. The composition of the basket and the relative importance of items in it relate to this population group as a whole – it represents the expenditures of all inscope households, not the expenditure pattern of the average household or of any particular household type or size. The basket comprises all consumer goods and services acquired over a twelve month period. It includes items acquired infrequently by an individual household (e.g. major electrical appliances, new motor vehicles), items that are acquired almost daily by all households (e.g. bread and milk) and items that are only available at certain times of the year. The basket includes, for example, both rent payments of renting households and the amounts paid by owner–occupier households for the purchase of their principal residence – clearly no individual household can incur both expenses at the same time. Therefore, changes in the CPI are unlikely to reflect exactly the price experience of any particular household.

2.47 The CPI does not measure those changes in living costs which may be experienced by individual households as a direct consequence of their progression through the life cycle. For example younger households may incur a higher proportion of their expenditure on housing and child care while those households entering the older age groups may incur increasing expenditure on medical services. However, changes in the demographic make–up of households in aggregate and differences in expenditure patterns will affect the pattern of total household expenditure recorded in the HES. In turn, these changes will be incorporated in the weighting pattern in the CPI.

CPI cannot be used to measure price levels

2.48 The CPI is not designed to measure price levels; rather its purpose is to measure changes in prices over time. While price levels in country regions often differ from those in metropolitan areas (some higher and others lower), the factors influencing price movements generally tend to be similar. Therefore the CPI can be expected to provide a reasonable indication of the changes in prices in Australia as a whole in the longer term.

2.49 Similarly, the CPI cannot be used to compare price levels between capital cities. For example, the fact that the CPI All groups index in the September quarter 2011 for Adelaide (183.6) was higher than in Perth (178.8) does not indicate that Adelaide was more expensive to live in than Perth. Rather, it indicates that prices in Adelaide have risen more than in Perth since 1989–90.

2.50 At the end of the day, the CPI is most useful as an indicator of price movements, whether it be for specific items, a particular city, or the economy as a whole. The CPI is not a precise measure of individual household price experiences.


EXAMPLE: ADJUSTING FOR QUALITY

2.51 To illustrate the process used to adjust for changes in the quality of items priced in the CPI, consider the case of a change in the size of a can of tomato soup. In this example, Acme brand tomato soup is priced in three periods (1, 2 and 3) and the size of the can is reduced from 440gms to 400gms between period 2 and period 3:



Using the observed prices produces the following measures of price change:

Percentage change from Period 1 to Period 2	Percentage change from Period 2 to Period 3	Percentage change from Period 1 to Period 3
(2.78 – 3.09)/3.09 x 100	(2.85 – 2.78)/2.78 x 100	(2.85 – 3.09)/3.09 x 100
= –10.0%	= 2.5%	= –7.8%

2.52 However, this does not provide a measure of 'pure price' change because the item priced in period 3 is not identical to the item priced in the previous periods. What is required for period 3 is the 'price that would have been paid for the item that was priced in period 2'. This price can be estimated by adjusting the period 3 price by the ratio of the item's weight in period 2 to its weight in period 3, giving a quality adjusted price of $3.14 ($2.85 x 440/400).

Using this adjusted price in period 3 results in the following correct measures of price change:

Percentage change from Period 1 to Period 2	Percentage change from Period 2 to Period 3	Percentage change from Period 1 to Period 3
(2.78 – 3.09)/3.09 x 100	(3.14 – 2.78)/2.78 x 100	(3.14 – 3.09)/3.09 x 100
= –10.0%	=12.9%	=1.6%

2.53 After adjusting for the reduction in quality between periods 2 and 3, the rise in the observed price of 2.5% has been translated into a pure price increase of 12.9%. Similarly, the measure of price change between periods 1 and 3 has been changed from a fall of 7.8% to a rise of 1.6%.