Definition
CPI (Consumer Price Index) and RPI (Retail Price Index) are both measures of inflation, however, they differ in their method of calculation and items they cover. CPI excludes housing costs such as mortgage interest payments and council tax, making it a typically lower and more internationally recognized measure of inflation. RPI, on the other hand, includes these costs and some adjustments reflecting changes in interest rates, thus usually resulting in a higher reported inflation rate.
Key Takeaways
- Measure Different Basket of Goods: The Consumer Price Index (CPI) and the Retail Price Index (RPI) both measure changes in the price level of a market basket of consumer goods and services, but the basket of goods that each uses is different. CPI basket is more comprehensive and includes more categories of spending (like tuition fees, for example), while RPI also accounts for housing costs.
- Calculation Method: The method of calculation also differentiates CPI and RPI. CPI uses a geometric mean calculation, which gives a lower weighting to goods and services that have significantly increased in price. In contrast, RPI uses an arithmetic mean, giving equal weighting to all items irrespective of price changes.
- Use and Application: CPI is typically used for macroeconomic purposes and is often the measure policymakers refer to when setting monetary and fiscal policy. On the other hand, the RPI is often used for adjusting pensions and other benefits for inflation, or for inflation-proofing the returns on investments.
Importance
CPI (Consumer Price Index) and RPI (Retail Price Index) are both important measures of inflation in an economy, but they involve different calculations and consider distinct sets of goods and services.
The importance of understanding the difference between the two lies in their application and implications for financial decision-making.
CPI, which excludes housing costs, is typically used by governments for inflation targeting and setting monetary policy.
RPI, which includes mortgage payments and other housing costs, often results in a higher inflation rate, and is commonly used for adjusting pensions and other public spending.
Therefore, the choice to use CPI or RPI could significantly affect economics policies, business planning, personal finance strategies and wage bargaining.
Explanation
The Consumer Price Index (CPI) and the Retail Price Index (RPI) are both measures of inflation that are used to evaluate the average changes over time in the prices of goods and services purchased by households. The CPI is a crucial tool for economic policy decisions, guiding central banks in adjusting interest rates to keep inflation within target rates. It’s widely used in making international comparisons, as it adheres to a global standard set by various international organizations like the International Monetary Fund and the World Bank.
It ensures that each country’s inflation rate can be compared to others in an equitable and transparent manner. On the other hand, RPI is typically used in the UK to negotiate wage increases and to calculate state pensions and many other social security benefits as well. While CPI only accounts for spending by households, RPI goes a step further and includes the expenditure of businesses, central and local government, and foreign tourists.
Therefore, governments and companies use RPI to help gauge how much to increase pensions, benefits, rail fares, and student loan repayments each year. It also includes costs such as mortgage interest rates and council tax, which are excluded from the CPI. Therefore, the differences in their calculation result in RPI usually being higher than CPI.
Examples of CPI vs RPI (Top Differences)
The Purchase of Consumer Goods: In the UK, the two main measures used to track inflation are the Retail Prices Index (RPI) and the Consumer Prices Index (CPI). Imagine you are a common citizen buying everyday goods like milk, eggs, fruits, etc. While the prices of these goods can go up over time, the rate of this increase can be measured using different indicators. If you use CPI to measure the inflation rate, it doesn’t consider housing costs such as council tax and mortgage interest payments. But, if you are using RPI, it considers these costs. Thus, for someone with a home mortgage, the RPI could provide a more accurate representation of their monthly expenses and overall cost of living increases than the CPI.
Railway Fares: In the UK, rail fares were annually increased by the rate of RPI inflation but in August 2021, this was switched to use the usually lower CPI figure. This is a real world example of how these two different measures can impact consumer costs, potentially saving rail commuters in the UK hundreds of pounds per year.
Pension Payments: In Britain, many occupational pensions are tied to inflation to help ensure that they retain their value over time. The type of index used to measure inflation has real-world impacts on these payments. For example, if a pension plan is indexed to the RPI, then the annual increase in payments might be higher than if it was indexed to the CPI. This is because the RPI generally gives a higher measure of inflation than the CPI. Thus, pensioners receive larger annual increases if their payments are tied to RPI rather than CPI.
FAQ: CPI vs RPI (Top Differences)
What is CPI?
CPI, or Consumer Price Index, is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care.
What is RPI?
RPI, or Retail Price Index, is also a measure of inflation, but it calculates the average price increase of a basket of goods and services, including mortgage interest payments and housing costs.
What are the main differences between CPI and RPI?
The main difference between CPI and RPI is that RPI additionally includes housing costs such as mortgage interest payments and council tax, whereas the CPI does not. Moreover, CPI and RPI use different statistical formulas to calculate inflation.
Why might CPI be preferable over RPI?
CPI might be preferred over RPI as it is typically lower than the RPI and it is the measure the UK government has chosen for its official inflation target. Furthermore, CPI is seen as a more internationally comparable measure of inflation.
Why might RPI be preferable over CPI?
RPI could be preferred over CPI in situations where it is important to include housing costs. For example, for wage negotiations, RPI may be a better measure as it may more accurately represent the cost of living for households that have a mortgage or are paying council tax.
Related Entrepreneurship Terms
- Base Year: This is a key term in both CPI (Consumer Price Index) and RPI (Retail Price Index) as it refers to the reference year against which price changes are measured.
- Statistical Measures: Both CPI and RPI are statistical measures used to track changes in the price of a basket of goods and services over time.
- Market Basket: The basket of goods and services that are used to calculate the CPI and RPI. These typically include food, clothing, transportation, and healthcare.
- Inflation: A term commonly linked with CPI and RPI as they both serve as key measures of inflation. It refers to the rise in the general price level of goods and services in an economy over a period of time.
- Interest Rates: The CPI and RPI can influence the setting of interest rates by central banks, as they aim to control inflation.
Sources for More Information
Sure, here are four reliable sources of information about the differences between CPI and RPI:
- Investopedia: Provides in-depth articles explaining various financial terms and concepts including CPI and RPI.
- Financial Times: Offers news and analysis on UK and international finance, including understanding economic indicators such as CPI and RPI.
- Bank of England: As the UK’s central bank, they offer detailed insights and educational resources on economic indicators, including CPI and RPI.
- Economics Help: Another great resource that provides accessible information on economics including the difference between CPI and RPI.
