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What Is a Composite Price Index?

A Composite Price Index is a statistical tool that blends multiple individual price indices to track the overall price movement in an economy. It reflects the average price changes across a diverse range of goods and services, providing a comprehensive snapshot of inflation or deflation. How does this index affect your daily life and financial decisions? Explore with us to find out.
K. Kinsella
K. Kinsella

A composite price index is a statistical chart that is used to track changes in the average price of certain types of commodities, securities or even particular types of services. Some of these indexes are used to gauge the effects of inflation while others are used to track the performance of the stock market. While inflation causes many indexes to rise over time, a composite price index can also fall. This situation often occurs during periods of recession.

In the United States, the Standard and Poor's 500 (S&P 500) is a index of 500 stocks in major publicly listed companies. The index is seen as a barometer for the health of the economy, as these major firms are likely to prosper during boom times and to have reduced earnings during periods of recession. Mutual fund managers typically attempt to outperform the index over long periods of time although some funds hold securities that match the precise make up of the S & P 500. These so-called index funds are popular with investors seeking income since many of the stocks on the index pay dividends. In the United Kingdom, investors track the performance of the Financial Times Stock Exchange 100 (FTSE 100), while other similar indexes are used by investors in other nations.

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Government agencies in many nations including the Australia, Canada, the United Kingdom and the United States use a composite price index to track changes in the cost of living. The exact make up of the index varies from nation to nation but in most instances the index includes the cost of housing and other basic commodities that are regularly bought by homeowners. However, in some countries some variable such as energy prices and the cost of food and excluded from the price index.

While each composite price index contains data related to specific types of services and commodities, the individual items that the index is comprised of can change over time. If a firm becomes insolvent or loses its market share, it can be removed from a composite price index such as the S&P 500 or the FTSE 100. In the past, inflation related indexes only tracked the cost of housing and it was only late in the 20th century that other prices were added to these indexes in some nations.

Aside from providing consumers and investors with useful information, many types of composite price indexes are used by government policy makers who are tasked with combating inflation and deflation. A drop in a stock market index is often the first sign of a recession while increases in the cost of living often prompt governments to increase interest rates so as to discourage spending. Furthermore, some analysts use records of past index movements to predict upcoming economic events.

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