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PAGE ONE Economics

®

What’s in Your Market Basket?
Why Your Inflation Rate Might Differ from the Average
Scott A. Wolla, Senior Economic Education Specialist

GLOSSARY
Consumer price index (CPI): A measure of
the average change over time in the
prices paid by urban consumers for a
market basket of consumer goods and
services.
Dual mandate: The Federal Reserve’s
responsibility to use monetary policy to
promote maximum employment and
stable prices.
Inflation: A general, sustained upward movement of prices for goods and services in
an economy.
Inflation rate: The percentage increase in
the average price level of goods and
services over a period of time.
Market basket: A selected group of consumer goods and services whose prices
are tracked for calculating a consumer
price index and measuring the cost of
living.
Price stability: A low and stable rate of
inflation maintained over an extended
period of time.

“Inflation is when you pay fifteen dollars for the ten-dollar haircut you
used to get for five dollars when you had hair.”

—Sam Ewing, Former professional baseball player

Does a dollar go as far as it used to? It might seem that you’re paying higher
and higher prices for the goods you buy. However, the data show that inflation has been virtually nonexistent for much of 2015. And the inflation rate
has been lower than the Federal Reserve’s 2 percent inflation goal for more
than 3 years.1 Nevertheless, when many people hear reports of lower-thanaverage inflation rates, they may not feel it reflects their experience as consumers. Where is the disconnect between the experience of individuals
and what the data show?

What Is Inflation?
Generally speaking, inflation means the average level of prices is rising.
More specifically, inflation is a general, sustained upward movement of
prices for goods and services in an economy. Prices have tended to rise
over time, which means that the inflation rate (the percentage increase
in the average price level of goods over a period of time) has been positive. And, as prices rise, the purchasing power of each dollar diminishes.
A 2 percent inflation rate means that (on average) a dollar buys 2 percent
fewer goods and services than it did last year. You might be surprised to
discover that even after accounting for the effect of rising prices (inflation),
average incomes have risen over time.2 So, while it’s true that prices generally rise over time, so do people’s incomes, which usually allows them to
purchase more goods and services.
Even though you rarely find people discussing rising prices as an economic
benefit, most economists believe that a low and stable rate of inflation is
beneficial for the economy.3 To this end, many central banks have a mandate of price stability, which means they are directed to intentionally
generate a low and steady rate of inflation. The Federal Reserve System,
the central banking system of the United States, has a dual mandate of

October 2015

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price stability and maximum employment
and has interpreted price stability as a 2 percent inflation objective.4

How Is Inflation Measured?
Inflation can be measured in a variety of ways,
depending on which “basket” of prices is
measured and how those prices are weighted.
The most widely reported measure of inflation is the consumer price index (CPI). The
CPI measures the average change over time
in the prices paid by urban consumers for
a market basket of consumer goods and
services. The current CPI market basket was
constructed based on input from spending
diaries kept by 28,000 consumers and
NOTE: As stated in the essay, the average age of individuals in the United States is 37.6 years.
another 60,000 quarterly interviews conAssume here that the average person was born on January 1, 1978. Using FRED® to set the
ducted in 2011 and 2012. All this informaindex at 100 on that date, prices of all items in the CPI market basket have risen approximately
278 percent (blue line). However, when separated into categories, medical care has risen 653
tion was used to determine what people
percent (red line), while apparel has risen only 57 percent over that period (green line).
5
were actually buying. Data collectors visit
SOURCE: FRED®, Federal Reserve Economic Data, Federal Reserve Bank of St. Louis. Consumer
places of business to collect price informaPrice Index for All Urban Consumers: All Items, Medical Care, Apparel;
tion monthly to record the prices of about
https://research.stlouisfed.org/fred2/graph/?g=1AxN.
80,000 items that make up the market basket.6 The prices of goods and services in the
market basket are then “indexed” to make it
person living in the United States is 37.6 years9 and the
easier to compare changes in the price of the market basaverage income is $46,163 (personal income per capita).10
ket over time. To do this, the Bureau of Labor Statistics
Are you 37.6 years old with an income of $46,163?
sets the price of the market basket during a particular
time period equal to “100.” Changes in the index value
Chances are you don’t fit this average exactly. Similarly,
are used to measure inflation and calculate the inflation
your personal inflation rate will likely differ from the CPI
rate. For example, if the index rises from 100 to 103 in a
inflation rate. The CPI market basket is an average calcuyear, the inflation rate for that 1-year period is 3 percent.
lated to reflect the spending of the average urban houseAlso, notice the use of the word “urban”; the CPI is meant
hold, not any specific individual household.
to reflect the purchases of the typical urban consumer,
Because each individual buys a different basket of goods
which represents about 87 percent of the U.S. populaand services, potentially every person has his or her own
tion.7,8 People who live in rural nonmetropolitan areas,
inflation rate. Your personal inflation rate depends on
farm families, people in the armed forces, and those in
how
you spend your money. For example, let’s assume
institutions are not included in the calculation; therefore,
you hit the “average person” mark fairly closely: You are
the CPI does not attempt to reflect price changes for
about
37.6 years old, born on January 1, 1978. During
these consumers.
your lifetime, the prices of all items in the CPI market
basket have risen approximately 278 percent (an average
Your Personal Inflation Rate
annual rate of 3.7 percent). However, when separated
Statistics are often reported as an average, but that averinto categories, medical care has risen 653 percent (an
age might not reflect the experience of any given indiaverage annual rate of 5.6 percent), while apparel has
risen only 57 percent (an average annual rate of 1.3 pervidual in the sample. For example, the average age of a

PAGE ONE Economics®
cent) since your birth. You can likely see how your individual market basket influences your personal inflation
rate (see the figure). If you have spent a larger portion of
your income on medical care, for which the average price
has risen faster than most prices, your personal inflation
rate has been higher than the CPI inflation rate. On the
other hand, if your twin sister has spent a larger portion
of her income on clothes, for which the average price has
risen more slowly than most prices, her personal inflation
rate has been lower than the CPI inflation rate.

The Everyday Price Index
The Everyday Price Index (EPI), published by the American
Institute of Economic Research (AIER), is designed to
reflect price changes for the goods and services people
buy frequently—at least once per month. The index uses
the CPI but simply pulls the goods and services purchased
on a day-to-day basis out of the CPI basket and puts them
into the EPI basket. In other words, it creates a smaller
market basket that includes only these everyday goods
and services. Note that the EPI is not meant to reflect
total consumer spending; rather, it is meant to reflect
the “price changes felt by Americans on a day-to-day
basis.”11 The AIER tracks and reports monthly on the
inflation rate of this market basket.
The EPI focuses on purchases that consumers cannot
easily postpone or forgo (such as food, fuel, and prescription drugs). Consumers must absorb the fluctuations in
prices as they happen. The largest categories in the EPI
basket (comprising nearly half ) are food at home (21.5
percent), food away from home (15.1 percent), and household fuels and utilities (13.4 percent).12 By contrast, the
BLS gives those same categories much lower weights in
the CPI market basket: food at home (8.4 percent), food
away from home (5.8 percent), and household fuels and
utilities (5.2 percent).13 Goods such as cars, appliances,
and furniture are not included in the EPI simply because
they are not everyday goods. They are purchased infrequently, or consumers can sometimes delay the purchase
of these goods.14 The EPI also excludes goods with prices
fixed by contract, such as mortgage and rent payments,
because consumers are protected from price increases
during the contract period. This smaller market basket is
more volatile than the much larger CPI market basket.
Over the past 20 years, the EPI indicates that everyday
prices have risen by 76 percent (an average annual rate

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Perception and “Visible” Prices
People notice price changes for some goods more than others.
For goods purchased frequently—such as gasoline, food, and
clothing—a price change is more noticeable than a price change
in goods bought less frequently, such as appliances. For example,
gasoline prices are among the most visible prices to consumers;
they are posted on lighted signs on busy roads throughout the
country. Because gas prices are so visible, price fluctuations are
likely to influence perceptions of inflation and inflation expectations more than prices for less visible goods or those purchased
less frequently.1 In addition, these goods (gasoline, food, and
clothing) often have relatively large price swings because of seasonal shifts in supply and demand.2 Noticing price changes in
some goods in the market basket, but not others, may leave consumers with the perception that inflation is higher or lower than
the inflation rate as measured by the CPI.
1 Coibion, Olivier and Gorodnichenko, Yuriy. “Is the Phillips Curve Alive
and Well After All? Inflation Expectations and the Missing Disinflation.”
NBER Working Paper No. 19598. National Bureau of Economic Research,
October 2013; http://www.nber.org/papers/w19598.pdf.
2 U.S. Bureau of Labor Statistics. “The Consumer Price Index—Why the
Published Averages Don’t Always Match an Individual’s Inflation Experience.” October 16, 2001; http://www.bls.gov/cpi/cpifact5.htm.

of 3.2 percent), while the CPI indicates that prices have
risen by 56 percent (an average annual rate of 2.3 percent). The EPI might be helpful in explaining the difference between the actual (lower-than-average) inflation
rate and the perception by many people that prices are
rising quickly. Differences in the visibility of certain prices
might also impact your perception of inflation. For more
information, see the boxed insert, “Perception and ‘Visible’
Prices.”

Conclusion
The CPI is designed to reflect the purchases of the typical
urban consumer, and not all people are typical or urban.
More importantly, the CPI is meant to reflect the experience of the average household, but differences in individual consumer choices nearly guarantee that the inflation rate experienced by any individual varies from the
average inflation rate. In addition, the prices of some
goods that are more visible might influence people’s perception of inflation because the prices are both noticeable and volatile. In short, it is good to remember that
when it comes to national statistics such as the CPI, actual
(individual) results may vary. ■

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Notes
1 “Inflation

9

2

10 FRED®, Federal Reserve Economic Data, Federal Reserve Bank of St. Louis.
Personal Income Per Capita;
https://research.stlouisfed.org/fred2/series/A792RC0A052NBEA.

Misses Fed’s 2% Target for 38th Straight Month.” Real Time Economics
(blog), Wall Street Journal, August 3, 2015; http://blogs.wsj.com/economics/
2015/08/03/inflation-misses-feds-2-target-for-38th-straight-month/.
Real disposable income per capita in the United States has increased by 221
percent since April 1960 (see https://research.stlouisfed.org/fred2/graph/?g=1sPx).

3

Economists prefer a small “inflation buffer” to reduce the risk of deflation. For a
more detailed discussion of inflation in the context of price stability, see Wolla,
Scott A. “Money and Inflation: A Functional Relationship.” Federal Reserve Bank of
St. Louis Page One Economics Newsletter, March 2013;
https://research.stlouisfed.org/publications/page1-econ/2013/03/01/moneyand-inflation-a-functional-relationship/.
4

Board of Governors of the Federal Reserve System. “Press Release.” January 25,
2015; http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm.
Note: While the Federal Reserve considers many measures of inflation in its
assessment of the economy, its inflation objective is stated in terms of the personal consumption expenditures price index (PCEPI).

Central Intelligence Agency. The World Factbook. Updated July 15, 2015;
https://www.cia.gov/library/publications/the-world-factbook/geos/us.html.

11 Cangero, Theodore; Delorme, Luke F. and Vlasenko, Polina. “Improving the
Everyday Price Index.” May 16, 2014;
https://www.aier.org/research/improving-everyday-price-index.
12

Cangero, Theodore. “Poultry and Eggs Lead Food Prices Higher.” July 17, 2015;
https://www.aier.org/research/poultry-and-eggs-lead-food-prices-higher.
13 U.S. Bureau of Labor Statistics. “Table 1 (2011-2012 Weights). Relative Importance

of Components in the Consumer Price Indexes: U.S. City Average, December 2014.”
http://stats.bls.gov/cpi/cpiri_2014.pdf.
14

Cangero, Theodore and Delorme, Luke F. “EPI Methodology.” May 15, 2014;
https://www.aier.org/research/epi-methodology.

5 U.S. Bureau of Labor Statistics. “Consumer Price Index. FAQs: Question 6.”
Updated September 17, 2014; http://stats.bls.gov/cpi/cpifaq.htm#Question_6.
6 U.S. Bureau of Labor Statistics. “Consumer Price Index. FAQs: Question 8.”
Updated September 17, 2014; http://stats.bls.gov/cpi/cpifaq.htm#Question_8.
7 U.S. Bureau of Labor Statistics. “Consumer Price Index. FAQs: Question 3.”
Updated September 17, 2014; http://stats.bls.gov/cpi/cpifaq.htm#Question_3.
8 The Federal Reserve Bank of Atlanta offers a CPI tool that may more accurately
reflect an individual household’s market basket. Its myCPI tool allows you to track
the prices of a market basket more like yours and compare your CPI with the
national average. See
https://www.frbatlanta.org/research/inflationproject/mycpi.aspx.

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