When the cost of food rises, does the CPI assume that consumers switch to less desired foods, such as substituting hamburger for steak?As for the Ferrari example? It's so dumb I can't wrap my mind around it.No. In January 1999, the BLS began using a geometric mean formula in the CPI that reflects the fact that consumers shift their purchases toward products that have fallen in relative price. Some critics charge that by reflecting consumer substitution the BLS is subtracting from the CPI a certain amount of inflation that consumers can "live with" by reducing their standard of living. This is incorrect: the CPI's objective is to calculate the change in the amount consumers need to spend to maintain a constant level of satisfaction.
Specifically, in constructing the "headline" CPI-U and CPI-W, the BLS is not assuming that consumers substitute hamburgers for steak. Substitution is only assumed to occur within basic CPI index categories, such as among types of ground beef in Chicago. Hamburger and steak are in different CPI item categories, so no substitution between them is built into the CPI-U or CPI-W.
Furthermore, the CPI doesn't implicitly assume that consumers always substitute toward the less desirable good. Within the beef steaks item category, for example, the assumption is that consumers on average would move up from flank steak to filet mignon if the price of flank steak rose by a greater amount (or fell by less) than filet mignon prices. If both types of beef steak rose in price by the same amount, the geometric mean would assume no substitution.
Unfair to seniors, military retirees, etc. What is hard to understand about the example of an expensive car going down, when the article is about the CPI dropping because deals on air travel, autos, and clothing? Did you read the article?
***By Emma Margolin
hardball
updated 4/6/2013 9:17:48 AM ET
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President Obama’s controversial budget proposal uses a formula called “chained CPI.” Here’s what you need to know about how it’s calculated, and how it may affect you.
And you thought the term “sequestration” was bad…
Details of President Obama’s proposed budget leaked on Friday, signaling his intention to cut Social Security and other benefit programs by way of a revised inflation adjustment known as “chained CPI.”
The proposed budget–expected to be released next week–enraged many on the left, who felt Obama had betrayed “the core of the progressive and Democratic legacy,” said Stephanie Taylor, co-founder of the Progressive Change Campaign Committee, in a statement on Friday. Critics on the right were also angered by the rumored cuts, which House Speaker John Boehner belittled as, well, too little. “If the president believes these modest entitlement savings are needed to help shore up these programs, there’s no reason they should be held hostage for more tax hikes,” he said in statement released Friday. “That’s no way to lead and move the country forward.”
But while many commentators were busy being outraged, others were merely confused. So for those of you wondering, “What the heck is ‘chained CPI,’ and why is everyone so mad about it?” here are some FAQs.
What is the CPI?
The consumer price index, or CPI, is a formula that measures the prices of goods and services we buy and how they change over time. These good and services include everything with a price tag, like food, housing, and clothing. The CPI is used to calculate cost-of-living adjustments–COLA–which affect how much money you receive from programs like Social Security. When cost-of-living-adjustments go up, you get a bigger check from the federal government.
How is that different from “chained CPI?”
The chained CPI slows the growth of entitlement programs by assuming that when prices go up for something, people switch to cheaper substitutes. That is, if the price of steak goes up, people will skip the steak and buy chicken instead. And if people aren’t necessarily paying more for their goods, they don’t need their benefits to rise. Estimates show that under the chained CPI, your cost-of-living adjustment would be about .3 percentage points below the plain CPI, which means you won’t see as big an increase in your Social Security check.
Can I see an example?
Sure. Let’s say your monthly Social Security check last year was $2,000. Using the CPI, the Social Security Administration found that the cost of living adjustment for this year was 1.7 percent. To calculate your new social security check, you take last year’s check and multiply it by your cost of living adjustment (COLA) for this year. You then add the result to last year’s check to get the new number. So here we go: 2,000 x .017 = 34. Using the CPI, your monthly Social Security check would have increased from $2,000 to $2,034.
Using the chained CPI, your COLA comes out to .3 percentage points lower–so instead of 1.7 percent, it’s now 1.4. 2,000 X .014 = 28. Your monthly Social Security check is now $2,028–$72 less a year than you would be getting using the plain CPI formula. Sounds tiny? The switch could save $130 billion.
What are the drawbacks?
Pay attention: this is the key part. Some analysts fear the chained CPI switch unfairly burdens seniors, who tend to have more health care needs–which, unlike food or clothing choices, are not “elastic.” If you need blood-pressure medication, you still need it even if (or when) the price rises. You can’t simply choose to have a different medical condition that happens to be cheaper to treat. And if you’re not free to substitute chicken for steak, the fundamental economic assumption that drives the chained CPI no longer applies. “Seniors have a different consumption basket from the young, one that includes more medical expenses, and [they] probably face true inflation that’s higher, not lower, than the official measure,” wrotePaul Krugman in The New York Times Friday. “This is, purely and simply, a benefit cut.”***