Written by: Jevons16
CPI is simply the measure of the average price of goods and services bought by a consumer in a certain economy at particular time. It is used as an economic indicator in many countries including the US among other developed countries. CPI is mainly used in determining the living standards of various households in the country as well as the effects of inflation on all consumers.
It is computed by simply taking an average of the prices of various item in the basket of goods. All items in this basket must have been used consistent for extended periods. This is meant to ensure that the products used are highly demanded by various consumers for the stated period.
However useful the consumer price index is, is reported to be unreliable in the measure of inflation due to the increase in the living costs including, housing bills, school related cost and even the costs of owning a vehicle which are not included in the entire computation. This guide is therefore meant to look into details the various reasons as to why CPI is not a good indicator of inflation and also the relationship between minimum wages and the cost of living over years.
Weaknesses of CPI
- Lack of individual relevance As mentioned earlier on, CPI represents the overall price of goods and services consumed by all consumers and there is no indication of the spendings of a particular consumer. If the spendings of a particular consumer are too high as compared to those of an average consumer, then CPI cannot be relevant to that specific consumer. For instance the rich people tend to spend more on costs such as housing, schooling and car expenses as compared to the middle class people in the society and if CPI is used as an economic indicator then inflation can not be appropriate as compared to that of a middle class person.
- The substitution bias Inflation computation based in a fixed basket of goods may also not be accurate as consumers cost of living differs over time. Assuming that the general price of the fixed goods increases by 30% and your income also increases by the same rate, is it necessarily that you keep consuming the same products? Definitely your consumption patterns will be altered and since CPI does not accommodate these changes it is reported to be unreliable in the measure of inflation.
When the price of certain products increase, consumers will tend to buy less quantities of such goods and instead buy more of their substitutes whose prices are lesser. Since CPI does not include these substitution effects inflation may thus be overestimated.
- CPI does not take into account the innovation of new products CPI only includes those products that are used for a continued duration and are also consumed in large quantities. New products are therefore excluded in the computation and can take time before they can be included in the computation. If a new car model is introduced in the market for instance it will take a some years for it to be included in the CPI despite its use by a few people in the economy. This therefore states out that CPI is not a reliable measure of a country’s economy since it does not include new commodities in the market.
- Changes In the quality of products The consumer price index does not also account for changes in the quality of the various products. The quality of various products changes overtime but these changes are not at all reflected in their prices. This
basically means that the consumers cost of living will be overestimated due to the high price of these goods which is not a true figure. The change in the quality of various products maybe difficult to determine but new ways should be introduced to determine the actual values of goods computed in the CPI. An actual value of the current goods being used would be important to reflect the real value of the CPI
The Minimum wage concept Several politicians in the US strongly pushed for the increase in the minimum wages. Bernie Sanders are among the top officials who argued for the rise of the minimum wage to $15 per hour so as to improve the living standards of the workers. In the past years, low minimum wages have always contributed to the living standards of the low income earners. The increase in the minimum wages was thus meant to find a solutions to workers struggling to make their ends meet.
Minimum wage refers to the lowest rates upon which employers are allowed to pay their workers. Any payment below the set amount is therefore not legally acceptable. Increase in the minimum wage to a certain value then simply means that workers can enjoy more earnings and hence be able to finance their needs. Employees will also have some funds to save for their future needs and even accumulate amounts with which they can invest. This will as a result boost the countries economy due to the large amounts of money flowing in the economy. Cost of living will also be reduced as people will have enough funds to finance their needs from their investments.
Despite the various limitations stated above on the reliability of CPI, it still remains as one of the widely used methods in determining the living standards of households as well as the inflation rates. However, it is very important to recognize the various weaknesses and hence provide the possible solutions to make it a reliable measure of the country’s economy.
Countries like the US are pushing hard to ensure that the minimum wages are increased by an higher rate to enable employees cater for their daily expenses. This is definitely a good move and it would be a good idea to be emulated by all countries. Laws on the minimum wages should also be enforced to ensure that all employers stick to the set minimum wage rates and that penalties apply to the business entities that violate such laws.