AQA Specification focus:
‘A detailed technical knowledge is not expected of indices such as the Retail Prices Index (RPI) and Consumer Prices Index (CPI), but students should have an awareness of their underlying features, for example, the concept of the ‘average family’ and a ‘basket of goods and services’.’
Understanding the underlying features of the CPI and RPI is essential to appreciate how these indices measure inflation, reflecting consumer experiences through the basket of goods and services.
CPI and RPI as Measures of Inflation
The Consumer Prices Index (CPI) and Retail Prices Index (RPI) are the two most commonly cited measures of inflation in the UK. Both attempt to capture changes in the general price level, but they differ in methodology and coverage. While a detailed technical knowledge is not required for AQA A-Level Economics, students should grasp their key features to understand how inflation statistics are generated and interpreted.
The Concept of the ‘Basket of Goods and Services’
One of the most important features of CPI and RPI is the basket of goods and services. This refers to a representative collection of items that reflect what households typically buy.
Basket of Goods and Services: A representative sample of consumer products, including goods and services, used to measure changes in prices over time.
The basket is regularly updated to reflect changing consumer habits.
This ensures that the indices remain relevant to current spending patterns.
Composition of the Basket
The basket typically contains hundreds of items ranging from food, clothing, and fuel to leisure activities and electronic devices.
Items are chosen based on household expenditure surveys and market research.
Each item is given a weight depending on its importance in the average household budget.
The ‘Average Family’ Concept
Another feature underpinning CPI and RPI is the idea of the ‘average family’. Since no two households spend in exactly the same way, statisticians construct a model household that reflects typical consumption patterns across the country.
Average Family: A statistical construct representing the typical household’s spending patterns, used to approximate consumer experiences in price indices.
The indices are therefore not designed to capture every family’s exact situation but rather to provide a national average. Some households may face higher or lower inflation depending on their personal consumption mix.
Implications of the ‘Average Family’
If an individual spends more on items whose prices rise quickly (e.g., fuel), their personal inflation rate may be higher than the CPI figure.
Conversely, if they spend heavily on items whose prices are stable or falling, their experience may differ from the reported index.
This illustrates why the CPI and RPI provide an approximation rather than a precise measure of inflation for each household.
Updating the Basket and Weights
The basket of goods and the weights assigned to them are reviewed annually. This is crucial because consumer spending patterns evolve over time.
Processes of Updating
Item Inclusion and Removal: Goods no longer widely purchased are dropped, while emerging products are added.
Changing Weights: Categories such as housing, transport, or food may increase or decrease in weight depending on their share of total household expenditure.
Reflecting Lifestyle Changes: The rise of digital products, healthier food choices, or eco-friendly goods demonstrates how social and cultural shifts influence the basket.
This updating process ensures that the indices maintain accuracy and continue to reflect modern household consumption.
CPI versus RPI: Differences in Coverage
Although both indices use a basket and the average family concept, they differ in important respects:
Coverage: CPI excludes some housing costs (such as mortgage interest payments), while RPI includes them.
Population Groups: RPI excludes the highest-income households and pensioner households mainly reliant on state benefits, whereas CPI covers a broader range.
Formulae: CPI uses a geometric mean in aggregation, while RPI uses an arithmetic mean.
These differences mean that RPI often shows a slightly higher rate of inflation than CPI.
Importance of Weights in the Basket
The weights in the basket are essential to ensure that the index reflects relative importance. For example:
Petrol receives a larger weight than newspapers because fuel spending forms a higher proportion of household expenditure.
Luxury goods, though significant in price, may have smaller weights due to their limited share in the average budget.
This weighting system prevents small or infrequently purchased items from distorting the measure of inflation.
Limitations of the Basket and ‘Average Family’
Despite their usefulness, the basket and average family concept come with limitations:
Individual Variability: No two households are identical in spending habits.
Regional Differences: Costs of housing, food, and transport vary widely across different parts of the UK.
Substitution Bias: When prices rise, consumers may switch to cheaper alternatives, which the fixed basket may not immediately reflect.
Timeliness: Updates occur annually, meaning sudden changes in consumer behaviour may take time to be incorporated.
These limitations highlight why inflation figures should be interpreted carefully, recognising that they provide a general guide rather than an exact picture for all.
Why These Features Matter
The basket of goods and services and the average family concept are vital because they allow policymakers, businesses, and households to monitor price changes effectively. By grounding inflation in consumer spending patterns, CPI and RPI provide a practical measure that influences decisions on wages, pensions, interest rates, and taxation policy.
FAQ
The CPI basket is updated annually to reflect modern spending habits. Items that decline in popularity, such as DVDs, are removed, while newer items like streaming subscriptions may be added.
This ensures the index remains relevant to real consumer behaviour, preventing outdated items from distorting inflation measures.
New items are selected using data from household spending surveys, retail sales, and market research.
Items must represent a significant and growing share of household expenditure.
They should reflect changes in lifestyle or technology.
Regional and demographic differences are considered to ensure broad representation.
CPI represents the average family’s spending, but individuals may allocate their budgets differently.
For example, someone who spends heavily on petrol may experience higher inflation if fuel prices rise, while another focused on technology might face a lower rate.
The CPI basket assumes fixed consumption for the year, but in reality, consumers often substitute cheaper alternatives when prices rise.
This means actual spending behaviour may not be fully captured until the basket is updated, creating a potential gap between real inflation and reported figures.
RPI includes housing-related costs such as mortgage interest payments and council tax, unlike CPI.
This often results in RPI showing higher inflation during periods of rising interest rates, as these housing costs increase significantly and carry heavy weights in the index.
Practice Questions
Define the term ‘basket of goods and services’ as used in the measurement of CPI. (2 marks)
1 mark for recognising it is a representative sample of goods and services.
1 mark for stating it is used to measure changes in prices over time.
Explain how the concept of the ‘average family’ and the weighting of items in the basket influence the accuracy of CPI as a measure of inflation. (6 marks)
Up to 2 marks for explaining the idea of the ‘average family’ (e.g., reflects typical household spending but may not match every individual’s experience).
Up to 2 marks for explaining the role of weights (e.g., items with higher spending shares given greater importance in the index).
Up to 2 marks for linking these features to accuracy or limitations of CPI (e.g., ensures relevance to most households but may not fully capture regional or individual variations).
