Indexing is simply a comparison of averages from one period of time (or cycle) against another period of time. There are many different types of indexes.  For example, the Consumer Price Index (CPI) is a way to see how much the cost of living may be going up.  The government will make a list of goods and services, such as transportation, food, and medical care, and keep track of their costs to consumers over a period of time.  At the end of that period of time, they will figure the average cost for each item and compare those against a previous period of time. If the overall average cost is higher, percentage-wise, then there is inflation.  If the overall average cost is lower, then there is deflation.  This method is used to keep track of the cost of living, which is why the CPI is sometimes referred to as the Cost-of-Living Index.

For example, let’s say that in a six-month period, you go to the grocery store and buy 30 different types of food and household items.  In fact, during that six-month period, you buy each item five times. That six-month period is known as Cycle A or Index A. You keep your receipts and at the end of Cycle A, you figure out what the average cost of each item was during that period. Then, during the next six-month cycle (Cycle B) you go back and buy the same items five more times and average those.  You then compare the average cost of each item from Cycle B with Cycle A to see whether or not the average cost of each item went up or down, and if so, by what percentage? If the overall average increase in cost from Cycle B was 5%, then you would say that your Grocery Store Index is +5%.  In other words, every 6 months, your grocery store budget would need to increase by 5% to keep up with inflation.  Of course, to keep up with realistic costs, you need to repeat this process over and over again.

Note: The CPI gives more value (sometimes known as scoring) to some items in its index than others.  An item from a “lesser” category may have gone up in cost by 10% whereas an item from a “more important” category may have only gone up in cost by 2%.  If the “more important” item has a score of 20 and the “lesser” item has a score of 5, then you can’t say that the average price increase of those two items went up by 6% because they are scored differently.

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