Consumer price index (CPI) measures the changes in the composite price of a “basket” of goods and services during a given period as compared with the base period. CPI is an essential metric for data scientists in financial services.
A “basket” is a set of various commodities consumed and services received in the base period or the given period, grouped under the main headings such as:
- Food and beverages
- Clothing and footwear
- Fuel and lighting
- Housing
- Services
- Miscellaneous
It is common to exclude durable goods and non-consumption monetary transactions such as the contribution to provident fund, savings certificates, etc. The quantities consumed or the expenditures incurred on various groups are used as weights for the average retail prices prevailing in the locality concerned during the base and given periods.
Data scientists often use CPI as a feature in statistical and machine learning models for applications in fintech, banking, and consumer goods analytics.
Following are the steps to construct CPI from raw data:
1. Scope:
The first step is to specify the category of people, and the locality where they reside as a consumer price index number relates to a particular segment of the population, such as low- salaried employees, school teachers, industrial workers, etc.
2. Household Budget Inquiry and Allocation of weights:
The next step is to conduct a household budget inquiry of the category of people concerned to determine the goods and services to be included in the construction and to derive weights to be attached to them. This step has many practical problems as no two households have the same income groups and the same purchasing or consuming patterns.
3. Price Data:
The third step is to collect data on consumer prices of goods and services included in the basket. These prices (retail prices) should be obtained both for the base period and the given period from the locality in which the people concerned reside or from which they make their purchases.
4. Computation of the Index:
The last step is the computation of the consumer price index number with the help of an appropriate formula. For this purpose, one of the following two methods is employed with the same result.
- The Aggregate Expenditure Method.
- Household Budget Method.