As a baseline is used to compare prices or track the performance of an entity, so also is the basket of goods strategy used to compare prices of given commodities. Considering that there is no general benchmark to ascertain the price of every good, experts have come up with a way to evaluate the worth and prices of commodities on the average.
What is a Basket of Goods?
Basket of goods is an economic term that is used to refer to a group of commodities used as a benchmark to compare prices. By doing this, analysts will be able to track and evaluate the official inflation rate. For example, if there is an increase or decrease in the cost of living the basket of goods strategy will be implemented to track the inflation rate and make necessary changes where possible.
Basket of Goods Explained
Appropriately tracking the inflation rate in a given economy would give the government an idea of the progress they are making as little changes can affect fiscal and monetary policies. Every economic-financial decision revolves around strategic units such as consumer choices, asset allocation, lending rates, etc., all units are capable of individually affecting the economy.
By processing the costs of goods within a basket consumer analysts are able to identify significant changes in prices per time and how these changes affect an average family budget in comparison to the government budget.
The most common benchmark of measuring price levels is the customer price index (CPI). Although there are other measures used to measure inflation such as producer price index (PPI) and the employment cost index. The CPI is more concerned with the inflation that is caused by consumer influence while the PPI focuses on inflation that is caused by production processes and labor market inflations are being measured by the employment cost index. Collectively, they all bring about economic inflation.
Using the CPI measure economists are able to appropriately measure the prices of commodities. Typically, a basket of goods contains about 80,000 selected commodities. From time to time, as the economy changes the items in the basket as also changed to meet up with recent trends. A basket of goods contains a list of different commodities such as beverages and processed foods, household appliances, fashion wears, health care costs, automobiles, gadgets, etc.
The Bureau of Labor Statistics (BLS) is the government body responsible for evaluating the prices of commodities. To arrive at an estimated amount or average, the BLS contacts at least 23,000 stores directly or indirectly, and contact about 50,000 landlords/tenants in approximately 87 urban areas to collect the prices of each good that is listed in the basket. The basket of goods is not a representation of physical goods in a basket but lists of grouped goods.
Once the necessary data has been collected experts would then process the information and make appropriate changes where necessary. Applying the baseline approach, once the average price per basket has been calculated the cost per basket of a current year will be compared against a previous year, preferably the starting year.