list three strengths and three weaknesses of the Consumer Price Index calculation.?

What Exactly Is the CPI?

The CPI measures changes in the prices of the things people buy and isolates them from changes in living standards. To do this, one must exclude any change in the amount households spend that is due to differences in the quality of what they buy or to changes in the kinds of purchases they make (i.e., their tastes) when those changes do not affect living standards. The task of isolating price changes from quality and taste changes makes the CPI one of the most complex of all the government's statistical indicators.

The first building block for the CPI is a sample survey of what urban Americans spend their money on. A sample drawn from the resulting detailed collection of items, weighted to reflect the importance of each in the typical household's budget, is referred to as a fixed market basket. The CPI tracks the price changes of this fixed market basket over the next decade or so, until a major revision of items and their relative importance in the index is undertaken.

Criticism of the CPI centers on three measurement problems:

* inadequate reflection of cost-reducing changes in consumption patterns as consumers switch to lower-price items,

* inadequate reflection of cost-reducing changes as consumers switch to lower-price outlets, and

* inadequate reflection of improvements in the quality of goods and services over time.

The CPI and the Bureau of Labor Statistics (BLS) have been caught in the political crossfire because the CPI affects both what the government pays out and what it takes in. It is used to adjust a large number of government benefits to preserve the real value of those benefits (including Social Security) from being eroded by inflation. When prices increase, the government pays out more in benefits. The CPI is also used to adjust income tax brackets to protect taxpayers from having to pay increased taxes when dollar incomes (but not the purchasing power of those incomes) have risen. When prices increase, this adjustment reduces the amount the government takes in taxes from a household whose income has remained the same in dollar terms.

A reduction of 1 percentage point in the CPI would save the government about $6 billion a year, a little more than half of that amount in reduced benefit payments and a little less than half that amount in increased taxes. That does not add up to a huge dent in the federal deficit (now running in the neighborhood of $200 billion a year), but it is certainly not trivial either. This is not the first time the CPI has been in the political spotlight. The difference is that previously the political fire came when inflation was in the double digits.

A rise in CPI, a key gauge of inflation, suggests higher prices that consumers have to pay but also means a stronger market demand.