Consumer Price Index (CPI) vs PCE Price Index
Consumer Price Index (CPI) and PCE Price Index are related concepts in AP Economics that students often mix up. The Consumer Price Index (CPI) is a price index tracking the cost of a fixed basket of goods a typical household buys, with the base year set to 100. PCE Price Index figures track prices for the consumption counted in the national accounts, published monthly by the Bureau of Economic Analysis. Here is how they compare side by side.
The Consumer Price Index (CPI) is a statistical measure that tracks the weighted average of prices of a basket of goods and services consumed by households. It is used to measure inflation, which is a sustained increase in the general price level of goods and services in an economy. The CPI is calculated by comparing the current prices of the basket of goods and services to a base period. This helps to determine the percentage change in prices over time.
PCE Price Index numbers cover what households consume as measured in the national accounts, and the Bureau of Economic Analysis releases them monthly with the personal income and outlays report. Two differences from the consumer price index drive most of the gap between them. The first is weighting: PCE draws on the business surveys behind GDP and counts goods and services bought on households' behalf, such as medical care paid by employers and government programs, which gives health care a much larger share. The second is substitution: PCE uses a chained formula whose weights update every period, so it reflects buyers shifting toward relatively cheaper items, while headline CPI holds its basket weights fixed for longer. Neither is the correct one and the other wrong; they answer different questions, and the Federal Reserve states its inflation goal in PCE terms.
CPI vs PCE: Two Measures of the Same Inflation
| Consumer Price Index (CPI) | PCE Price Index | |
|---|---|---|
| Who publishes it | The Bureau of Labor Statistics | The Bureau of Economic Analysis |
| Whose spending it covers | Out-of-pocket purchases by urban households | All household consumption in the national accounts, including what is paid on a household's behalf |
| How the basket is weighted | Weights held fixed between periodic updates | Weights updated continuously as spending patterns move |
| When shoppers switch between goods | Picks it up slowly, so measured inflation tends to run a little higher | Picks it up quickly, so measured inflation tends to run a little lower |
| Weight on medical care | Smaller, since only direct household payments count | Larger, since employer and government payments are included |
| Main use | Cost of living adjustments and inflation-indexed contracts | The measure the Federal Reserve points to when stating its inflation goal |
| Revisions | Left alone apart from seasonal factors | Revised as the national accounts are revised |
A fixed basket reads higher because shoppers do not keep buying the fixed basket
This is the difference that actually shows up in the numbers, and one worked case makes it clear. Suppose a household starts out buying 10 units of beef at 5 and 10 units of chicken at 4, so the basket costs 50 plus 40, which is 90. Beef then rises to 8 while chicken stays at 4. Price the original quantities at the new prices and you get 10 times 8 plus 10 times 4, which is 120, so a fixed-basket measure compares a new cost of 120 with an old cost of 90, an increase of about 33 percent. But the household does not buy that basket any more. Suppose it shifts to 4 beef and 16 chicken. Costed at the new prices that is 32 plus 64, which is 96, and the same quantities at the old prices would have cost 20 plus 64, which is 84, so the current-basket measure compares 96 with 84, an increase of about 14 percent. A chained index sits between the two, near 23 percent here. These figures are exaggerated to make the gap visible. The mechanics of building such an index are worked at /calculate/cpi.
The bigger difference is whose spending each one counts
Weighting is the famous difference, but coverage matters at least as much. The consumer price index tracks what urban households pay out of their own pockets. The PCE price index tracks consumption as the national accounts define it, which includes spending made on a household's behalf by an employer's insurance plan or by a government program. Medical care is where that shows up most sharply, since a household paying a small share of a hospital bill directly gives that bill a small weight in one measure and a much larger weight in the other. The two also differ in how they are used, and the use follows from the coverage. Out-of-pocket cost is the right idea for adjusting a pension, a wage contract or a tax bracket, so those are indexed to the consumer measure. Overall consumption prices are the right idea for a central bank steering the whole economy, which is why the Federal Reserve states its inflation goal in terms of the PCE measure. Neither is wrong. They answer different questions, and either can be recomputed excluding food and energy, which gives the version discussed at /glossary/core-inflation.
Frequently asked questions
What is the difference between CPI and PCE inflation?
The consumer price index measures the out-of-pocket cost of a basket of goods for urban households using weights held fixed between updates, while the PCE price index measures prices across all consumption in the national accounts using weights that move as spending shifts. The result is that the PCE measure usually reads slightly lower than the consumer price index over the same period.
Why does the Federal Reserve prefer PCE?
Because its coverage matches the consumption the central bank is actually trying to influence, including purchases made on households' behalf by insurers and government programs. Its weights also update as spending patterns change, which keeps the measure from drifting away from what people are really buying between basket revisions.
Which measure of inflation is more accurate?
Neither, because they are built to answer different questions. If you want to know how much more it costs a household to buy what it used to buy, the fixed-basket consumer measure is the right tool; if you want the price change across all consumption in the economy, the national accounts measure is.
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