What does the geometric mean formula do?
The modified Laspeyres formula currently used by the CPI estimates the price each month of a fixed basket of goods and services. In contrast, the geometric mean estimates the price of a varying basket of goods and services. If all prices within the basket increase by the same amount, say 5 percent, then both the modified Laspeyres and the geometric mean will show the index increasing by 5 percent. The two formulas will give different results, however, if prices of items within the basket increase by different proportions. For example, suppose that the sample market basket for lettuce in Boston consists of two items, a pound of iceberg lettuce and a pound of Romaine lettuce. If the price of iceberg lettuce increases from $1.00 to $1.50, while the price of Romaine lettuce remains equal to $1.00, then the price of the fixed market basket increases from $2.00 to $2.50, an increase of 25%. That is the price increase that would be reported by the current CPI formula. The geometric mean formu
