Question

Question 2 2. Describe the three problems in the construction of the CPI.

Answer 1

Since the Consumer Price Index (CPI) can be defined as a measurement which evaluates the weighted average of prices of a basket of consumer goods and services. For example transportation, food and medical care etc.

CPI of the last year= ∑PiQi

The problem which arises at the time of construction of the CPI are following;

1.

The selection of the base year;

The first difficulty arise at the calculating the CPI is the selection of the base year. The base year should be normal. But it is not easy to determine a truly normal year. This is because what may be the normal year today may become an abnormal year after some period. Therefore, it is necessary to keep changing the Base year at the interval of the 10 years rather than keeping it constant.

2

Difficulties in the Selection of Commodities:

The selection of representative commodities for the index number is also a difficult task. These should be selected from a wide range of commodities which the most of people consume. It is not necessay that what were representative commodities some ten years ago may not be representative today. Hence due to the change in the consumption pattern of consumers the index number become useless. Hence the choice of representative commodities presents real difficulties.

3. Difficulties in the Collection of Prices:

There is also a difficulty of collecting adequate and accurate prices. It is usually not possible to get them from the same source or place. Another problem arise due to the choice between wholesale and retail prices. There are much variations in the retail prices. Therefore, index numbers are based on wholesale prices.