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A: CONSUMER PRICE INDEX (CPI) I: Definition Consumer price index number is a measure that examines the weighted average

of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. The Consumer Price Index (CPI) is a key economic indicator used by government, business, labor, academia, and other organizations to monitor price movements of a fixed basket of goods and services commonly purchased by households over a period of time. Nonetheless, as time passes, consumption patterns change due to changes in consumer tastes, fashion, Technology and, most importantly, changes in the relative prices of the goods and services in the CPI market basket. These changes cause the fixed basket of goods and services to become out of date and lead to an index that does not accurately reflect price change giving inaccurate market signal to index users. For developing countries like Tanzania, the International Labor Organization (ILO) recommends rebasing the CPI at least once every five years in order to update the CPI market basket for the changes in consumer behaviors. II: WHAT THE CPI MEASURES? The CPI measures the changes in the price of a fixed basket of goods and services that are commonly purchased by a majority of households in a given country over time. To ensure that changes in the index reflect solely price changes, product specifications like quantities, quality and type of outlets are kept unchanged over time, in so far as it is possible. When changes do occur due to the closing of pricing outlets, or the discontinuance of a product that was being priced, similar outlets and/or products are introduced in a manner that ensures pure price changes are reflected in the index. This is done by splicing these new outlet or products into the index. In addition, it is also possible, in some cases, to carry out quality adjustments to the index that adjust the index for changes in product specifications. The CPI reflects the price movements and not the actual price levels of goods and services. Suppose indices for bread and buns for a particular period show a price percentage change of 10 % and 20% respectively. This does not mean buns costs more than bread, but it simply
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implies that the price of bread has risen by 10% while that of buns has risen by 20% from the based period III: TYPES OF CPI PRODUCED IN TANZANIA Several types of consumer price indices exist in Tanzania: NCPIthe National CPI is compiled based on monetary expenditures relating to consumption for all households both urban and rural with all levels of income. The NCPI Provides the headline estimate of inflation for the country. NCPI2the weights for this index are based on monetary as well as non-monetary Consumption. Non-monetary consumption includes imputed rent for homeowners and households living in rent free accommodations. The weights also reflect the market value of goods produced for own consumption such as food produced and consumed at home. Currently, the NCPI2 is compiled on an experimental basis for internal use. HCPIthe Harmonized CPI is compiled by member states of SADC/COMESA on the basis of strict guidelines. In particular, the HCPI weights do not include nonmonetary Expenditures. In addition, components for health care and education are not currently included. This index is compiled based on domestic expenditures that include expenditures by diplomats and visitors to the country. Likewise, expenditures by residents of Tanzania outside the country are not included. The HCPI will be released in early 2011. CICPIThe Core Inflation CPI provides an estimate of the underlying inflation rate. The CICPI is based on the NCPI. This index is compiled by excluding product and services that demonstrate highly variable price change. These include certain fresh fruits and vegetable and items such as fuel whose prices are determined exogenously to the economy of Tanzania. Also excluded are prices for water and electricity which are subsidized and administered by the government. It should be noted that the CICPI would be compiled and disseminated by the National Bank of Tanzania (NBT) rather than the NBS since it is an analytical index based on only part of the official NCPI

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B: SIGNIFICANCE OF THE CPI TO TANZANIA ECONOMY. i. Indicator of price changeThe CPI is the most common macro-economic indicator of price change. It is often used in the formulation of monetary policy and to identify the sources of price change. ii. Adjustment of economic seriesThe CPI is used as a price deflator in the compilation of real economic statistics and indicators, e.g., Gross Domestic Product (GDP) at constant prices. iii. For indexation of wages and salariesTrade unions and employers use the CPI for the indexation of wages and salaries in order to maintain the purchasing power of the wages and salaries. iv. For international comparisonsThe CPI is used to compare the inflation rate in Tanzania with that of other countries. These comparisons can then be used to appraise the relative economic performance of Tanzania with that of other countries. This may help determine economic and social policy for the country. C: PROBLEMS MEASURING CPI. While the CPI is a convenient way to compute the cost of living and the relative price level across time, because it is based on a fixed basket of goods, it does not provide a completely accurate estimate of the cost of living. Three problems with the CPI deserve mention: the Consumer Price Index is based only on a small fraction of the many goods and services that are available. If a person's buying habits differ substantially from the market basket on which the index is based, that person may experience a very different change in the cost of living than what the CPI shows. Substitution bias, the introduction of new items, and quality changes as explained below Substitution Bias The second problem with the CPI is the substitution bias. As the prices of goods and services change from one year to the next, they do not all change by the same amount. The number of specific items that consumers purchase changes depending upon the relative prices of items in the fixed basket. But since the basket is fixed, the CPI does not reflect consumer's preference for items that increase in price little from one year to the next. For example, if the price of backrubs in Tanzania jumped to Tshs 20 in time period 4 while the cost of bananas remained fixed at Tshs3, consumer would likely purchase more bananas and fewer backrubs. This
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intuitive phenomenon of consumers substituting purchase of low priced items for higher priced items is not accounted for by the CPI. Introduction of New Items Another problem with the CPI is the introduction of new items. As time goes on, new items enter into the basket of goods and services purchased by the typical consumer. For example, if in time period 4 consumers in Tanzania began to purchase books, this would need to be included in an accurate estimate of the cost of living. But since the CPI uses only a fixed basket of goods, the introduction of a new product cannot be reflected. Instead, the new items, books, are left out of the calculation in order to keep time period 4 comparable with the earlier time periods. Quality Changes The fourth problem with the CPI is that changes in the quality of goods and services are not well handled. When an item in the fixed basket of goods used to compute the CPI increases or decreases in quality, the value and desirability of the item changes. For example, if backrubs in time period 4 suddenly became much more satisfying than in earlier time periods, but the price of backrubs did not change, then the cost of living would remain the same while the standard of living would increase. This change would not be reflected in the CPI from one year to the next. While the National Bureau of Statistics attempts to correct this problem by adjusting the price of goods in the calculations, in reality this remains a major problem for the CPI measurements in Tanzania and rest of developing countries.

REFERENCES http://www.sparknotes.com/economics/macro/measuring1/section2.rhtml

http://en.wikipedia.org/wiki/Consumer_price_index http://ingrimayne.com/econ/Measuring/inflation3.htm http://www.investopedia.com/terms/c/consumerpriceindex.asp#ixzz2HN9OfxUp http://www.investopedia.com/university/releases/cpi.asp#ixzz2HNBi6xLr Ruth Minja And Dale A. Smith,( 201O),Methodology For Compilation Of National Consumer Price Index (NCPI) - Tanzania Mainland, National Bureau Of Statistics, Dar Es Salaam