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RPI vs CPI: Understanding Inflation Measures

The Retail Price Index (RPI) and Consumer Price Index (CPI) are two measures of inflation calculated through household spending surveys and price changes of commonly used goods. The RPI includes mortgage interest payments and uses an arithmetic mean, while the CPI excludes these payments and uses a geometric mean, leading to CPI generally being lower. Both indices have limitations, such as outdated baskets of goods and not accounting for quality changes or new products, which can affect the accuracy of inflation measurements.

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6 views2 pages

RPI vs CPI: Understanding Inflation Measures

The Retail Price Index (RPI) and Consumer Price Index (CPI) are two measures of inflation calculated through household spending surveys and price changes of commonly used goods. The RPI includes mortgage interest payments and uses an arithmetic mean, while the CPI excludes these payments and uses a geometric mean, leading to CPI generally being lower. Both indices have limitations, such as outdated baskets of goods and not accounting for quality changes or new products, which can affect the accuracy of inflation measurements.

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① RPI (Retail price Index)

- Two surveys are carried out to calculate the RPI.

- The first survey is a survey of around 6000 households, called the Living Costs
and Food Survey.

- This is used to find out what people spend their money on, e.g. petrol, apples,
haiircuts. The survey also shows what proportion oof income is spent on these
items. This is used to work out the relative weighting of each item – for example,
if 20% is spent on transport, then a 20% weighting will be given to transport.

- The second survey is based on prices – it measures the changes in price of


around 700 of the most commonly used goods and services (these goods and
services are often referred to as the “basket of goods”

- The items are chosen based on the Living Costs and Food Survey. What is in the
basket changes over time, because technology, trends and tastes change. This
ensures that the basket always reflects what the average household might spend
its money on.

- The price changes in the second survey are multiplied by the weightings from the
first survey. These are then converted to an index number. So inflation is just the
percentage change to the index number over time – e.g. if the index number rises
from 100 to 102, then inflation (based on RPI) is 2%.

- The weightings are important because the larger the proportion of a household’s
income that’s spent on an item, the larger the effect a change in the price of that
item will have on average spending.

② CPI(Consumer Price Index)

- CPI is calculated in a similar way to the RPI, but there are three main differences:

- Some items are excluded from the CPI, the main ones being : Mortgage interest
payments, Council tax

- A slightly different formula is used to calculate the CPI (CPI is geometric mean,
RPI is arithmetic mean of price changes )

- A larger sample of the population is used for the CPI

 The differences mean that the CPI tends to be a little lower than the RPI – the
exception is when interest rates are very low(because mortgage interest
payments, which increases when interest rates increase, is excluded from
CPI. )However, they both tend to follow the same long-term trend.

 The CPI is the official measure of inflation in the UK. Many other countries collect
data on inflation in a similar way to the CPI, so it’s often used for international
comparisons.

③ Limitations on both CPI and RPI as measure of inflation

- The RPI excludes all households in the top 4% of incomes. The CPI covers a
broader range of the population, but it doesn’t include mortgage interest
payments or council tax.

- The information given by households in the Living Costs and Food Survey can be
inaccurate.
- The basket of goods only changes once a year – so it might miss some short-term
changes in spending habits

- ★While price changes are reflected(even if it is once a year), quality changes are
not considered( what if price is twice but quality is also twice? Does that mean
the “price” of a good is increased by twice? )

- ★Introduction of new goods may be missed

- ★Substitution bias – people can substitute away from goods when their prices are
increased. But such substitution may not be reflected in CPI at that year, causing
an inflation rate calculated using a fixed basket of goods over time to
overestimate the actual rise in the cost of living.

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