Chain Weighted CPI - Defined.

Today Ben Bernanke Spoke of the Chain Weighted CPI.

Unlike the official fixed CPI, the Chain Weighted CPI reflects changes in consumer spending patterns. This is considered a much more accurate because it takes into account weight shifting. An example of weight shifting would be that I used to own three cars, but now that I telecommute, I only need one car (so I sell the cars and spend it on more computer supplies). Technically speaking, the chain-weighted price index measures the change in prices using the average of the quantities from one year to the next. Here is a mathematical example to better help you understand the difference:

George's Basket of Goods
2002: 2 Basketball shoes, 2 Tennis shoes
2003: 3 Basketball shoes, 1 Tennis shoes
Prices
In 2002 Basketball shoes costed $55, Tennis shoes costed $40
In 2003 Basketball shoes costed $50 Tennis shoes costed $55

Fixed Weighted Approach
Using the numbers from the table on the above, the calculated change in the Fixed CPI is [(2 basketball shoes x $50)+(2 tennis shoes x $55)]/[(2 basketball shoes x $55)+(2 tennis shoes x $40)]*100 = 110.5 or 10.5% inflation.
- note we used the 2002 quantities rather than the 2003 quantities.

Chain Weighted Approach
CPI is [(3 basketball shoes x $50)+(1 tennis shoes x $55)]/[(2 basketball shoes x $55)+(2 tennis shoes x $40)]*100 = 107.9 or 7.9% inflation.

Of course, these examples are simplified and not very realistic, but it gives you an idea of how the two approaches differ. Every tenth of a percent makes a difference in many pension plans, salaries, benefits and budgets for many companies, especially for the government. With Greenspan pushing for the chain weighted CPI, I wouldn't be surprised to see more organizations switch to it.

http://mutualfunds.about.com/cs/indicators/a/chainweighted.htm#