Final answer:
The CPI is calculated by dividing the current year's cost of a basket of goods and services by the base year's cost, then multiplying by 100. The base year serves as a standard with an index value of 100 for easy comparison of inflation rates.
Step-by-step explanation:
The Consumer Price Index (CPI) is a measure of inflation that reflects the change in price level of a fixed basket of goods and services. This basket represents the average consumer's purchases and is used to track changes in the cost of living over time. Specifically, the CPI is constructed by taking the current-year value of the basket of goods and services, dividing it by the base-year value of the same basket (the year chosen as a reference point or standard), and then multiplying the result by 100. The base year is an arbitrary year whose value is defined as 100, which allows for easy comparison of inflation rates over different years.
To calculate the CPI, government statisticians at the U.S. Bureau of Labor Statistics follow these steps: they determine the cost of the basket in the base year and assign it an index number of 100. Then, for subsequent years, they calculate the total cost of the same basket using current prices, divide this cost by the base-year cost, and multiply by 100 to find the index number for that year. If the index number for a given year is, for example, 105, there has been a 5% inflation since the base year.