This method is also known as Cost of Living Index Number (CPI). This index is to serve as a measure of change in the prices of goods and services commonly consumed by a homogeneous section of people, such as the classes – lower middle, middle, upper middle, industrial workers, urban and rural areas etc. These indices are helpful in deciding dearness allowances, wages/ salaries, negotiations, framing price policy, taxation policy, other economic and welfare policies.
The common method for selecting from the consumption basket is to conduct a family living style survey among the population group (section) for which the consumer price index is to be constructed. Prices of selected commonly consumed items are also collected from various retail markets used by such consumers and also the quantity of consumption [normally expressed in terms of weights (w)]. When the price of one commodity varies, a simple average is applied. For example, if index number is constructed for each of five groups using weighted average of the price group, the weights used are proportional to the expenditure on the consumed items by an average family. The overall index (CPI) is computed as an weighted average of group indices and the weights being again the proportional expenditure on different groups (e.g. 30 per cent on food).
