In the spring and summer of 2011, Americans were facing sticker shock at the gas pump: the price of a gallon of regular gasoline had risen from an average of $1.61 at the end of December 2008 to close to $4. Many other prices were also up. Some prices, though, were heading down: some foods, like eggs, were coming down from a run-up in late 2010, and virtually anything involving electronics was getting cheaper as well. Yet practically everyone felt that the overall cost of living was rising. But how fast?

Clearly, there was a need for a single number summarizing what was happening to consumer prices. Just as macroeconomists find it useful to have a single number representing the overall level of output, they also find it useful to have a single number representing the overall level of prices: the aggregate price level. Yet a huge variety of goods and services are produced and consumed in the economy. How can we summarize the prices of all these goods and services with a single number? The answer lies in the concept of a price index—a concept best introduced with an example.