Market Basket: Definition, How It's Used in Investing and Example

What Is a Market Basket?

A market basket is a selected group of products or assets designed to track the general performance of a specific market segment. This is sometimes known as a basket of goods.

Market basket economics focuses on the Consumer Price Index (CPI), which tracks various consumer goods and uses their price levels to provide an estimate of inflation. However, for investors, a market basket relates to financial securities and is the principle idea behind index funds.

"Baskets" can also be found in securities markets, where program traders may enter into a series of positions in several stocks or currencies at the same time.

How a Market Basket Works

A market basket refers to a selection of goods and services that are consistently purchased and sold throughout an economic system. Economists, politicians, and financial analysts use market baskets to track price changes over time and determine inflation levels. The most well-known and widely used market basket is the CPI, which helps economists predict consumer purchase trends. This basket is used to track inflation in a specific market or country.

The financial system uses market baskets like the S&P 500 and index funds, which are essentially a broad sample of stocks, bonds, or other securities in the market. This provides investors with a benchmark against which to compare their investment returns.

Special Considerations 

A market basket analysis is generally used in retail. It is based on the idea that most purchases are impulse buys, and the analysis attempts to predict what a customer might have purchased had the idea occurred to them.

Market basket analysts look at a group of items purchased by a customer and then try to determine what else that customer might buy if it was presented to them. Analysts use this information to decide where to locate items in a store, which demographics make certain purchases, what days of the week these purchases may be made, and what times of the year these customers spend the most money, among other considerations. 

Types of Market Baskets 

The CPI is an economic measure that looks at the average change in the price paid for a specific basket of goods and services over time. The CPI is used as a macroeconomic indicator, a deflating tool, and a way of adjusting monetary values over time. The CPI is not a cost of living index; instead, it is a measure of spending patterns and price levels for urban consumers and urban wage earners. The index, unlike various employment measures, takes into account the unemployed and the retired.

The market basket that the CPI uses is derived from information people provide regarding their spending habits. Over 200 categories of consumption within the CPI structure are analyzed to produce a mix of goods and services most representative of average purchases. Each category selected is given a weight regarding its proportion to the basket of goods. Some of the categories in the CPI's market basket include housing, transportation, recreation, apparel, and education.

The market basket used for the CPI also includes components outside the scope of consumer goods and services. Government fees of public goods, for example, like water and sewage, are included in the market basket. Taxes levied on the products and services already included in the market basket are also included. However, financial products like stocks and bonds are not included in the market basket. Essentially, the market basket represents all goods and services bought and sold by the population represented by the CPI.

Real World Example of a Market Basket

From 2020 to 2021, the CPI in the United States increased from 1.2% to 4.7%, which was the fastest rate of increase since 2017. The government credited this increase to the rising cost of gas, medical care, housing, and rent prices. This increase in the CPI implied inflation when prices in the basket of goods rose.

It is an indicator that people have confidence in the economy and are willing to spend. By monitoring the CPI and inflation, governments and central banks set monetary policies. Central banks of developed economies, including the Federal Reserve in the United States, generally aim to keep the inflation rate around 2%. After a long period of low interest rates, the Federal Reserve raised interest rates four times in 2018 to combat a strong economy and inflation. In June 2022 with the U.S. facing the highest inflation in 40 years, the Fed raised the rate by 75 basis points to 1.50%–1.75%.