Friday, September 7, 2007

The magic of Inflation

Business Standard reported, “Inflation based on the Wholesale Price Index (WPI) dropped to 3.79% for the week ended August 25 from 3.94% in the previous week. Inflation close to 7% few months back to 3.79% is more welcomed than ever. As one won’t be having any doubts regarding the importance of inflation to an economy and how it affects the economy, let’s see how it is calculated in India.

But before that, there are two methods to calculate inflation rate; Wholesale Price Index (WPI, introduced in 1902) and Consumer Price Index (CPI, introduced in the 1970s). In WPI, the calculation of inflation is done on the basis of the average rate of change in prices of a set of commodities in the wholesale market. Where as CPI is a statistical time-series value based on the weighted average of rate of change in prices of a set of goods and services purchased by consumers. Thus the CPI is much more comprehensive and it catches the inflation value from the end-consumer's side rather than from the wholesale seller's side. CPI is published on a monthly basis while WPI is available every week and has the shortest possible time lag of 2 weeks. India uses WPI while most of the developed countries use CPI to calculate the inflation rate.

The prices of a set of 435 commodities (such as onion, rice, dal etc.) are used for calculating WPI in India. Economists say that India should adopt CPI for inflation calculation as it is the one that shows price rise an end-consumer would experience. Finance Ministry counters it saying that in India there are 4 CPI indices (CPI Industrial Workers, CPI Urban Non-manual Employees, CPI Agricultural Labourers and CPI Rural Labour) in existence which makes switching over to CPI riskier and complex and also CPI has too much lag time in reporting. But then, the question remains how the United States, the United Kingdom, Japan, France, Canada, Singapore and China use CPI for inflation calculation?

The way in which WPI inflation rate is calculated in India can be found out in the article, How is WPI inflation rate calculated in India?.

Related Articles
- How is WPI inflation rate calculated in India?
- Commodities and their weight-ages in WPI calculation of India
- Inflation rates of India (2009)
- Inflation rates of India (2008)
- Base year and number of commodities used for inflation calculation in India


Ajith said...

Recently had this discussion in my micro economics class. ..As per what I understand, by doing this, Govt is showing to the press that inflation is less .. If we switch to CPI, the index might jump a notch higher which may affect the poll prospects :)

Jithu said...

> ajith
sorry for replying late. well wt u said cud be one of the reasons. but before u arrive at that conclusion i just wanted to point out one thing.

considering inflation as a relative term, price at consumer side (taken for CPI) is whole sale price (taken for WPI) + retailer margins. thus when u take CPI u add retailer margins, but this margin wud hv been there in the previous year (or base year) also. provided other factors remain same, if the retailer margins are constant in both current year and base year, CPI and WPI values will hv to be the same. if retailer margins are more current year, CPI wud be more than WPI. u can think abt all the combinations here.

what i am trying to say is, we may not be able to say that CPI inflation rate will always be more than WPI inflation rate and thats the reason why the govt. is not implementing it. bt there is no doubt abt CPI being more comprehensive and accurate, be it higher or lower than WPI.

Ghost said...

hi.. can anyone explain me on how inflation is calculated in India? I know that in India we use WPI .But i want to know , while announcing inflation rate on every friday, to which day's WPI we are comparing it with? what is the time period? In latest report it is given that infaltion rate is 7% does it mean that 100 rupee a year before is now 107 or 100 rupee on week before is 107 now?

Jithu said...

> ghost
Please have a look at the article, How is WPI inflation rate calculated in India? , in the same blog.

cashback said...

Good information it gives me a better insight thanks.

pnr said...

Thanks for all the informative articles. I read them because the Govt says the inflation rate is near-zero and hence I wanted know all about inflation!

Rajesh Purohit said...

CPI is not good for economy. E.g. CPI takes assumed price of electronic goods. Laptop costing 700$ in 2008 is cheaper than laptop costing 700$ in 2007. How? Because it has improved processing power and thus will result in more productivity. so its actual price is considered less and that results in lower inflation.
But, same laptop cost is considered higher if used in GDP calculation because of higher productivity.
Real inflation in UK is quite high, Milk/Bread/Butter/Egg/fruits and other vegetables are now costing more than double than previous year Still inflation high was 4.5% !! Even after Electricity and Gas prices had been up by 40-45%

Shuvankar Mukherjee said...

What need to be seen if the weightages and commodities considered are realistic and relevant? Mostly they are not?
For example food items should have much much higher weightage (as they are consumed by the entire population),on the Aviation Fuel has very little relevance.
Currently most urban and rural population do not believe that we have near 0% inflation.

Basic care has to be taken while setting up weightages:
Accessibility of any goods or products should be given highest priority. Then the acceptance of it in general population. The impact of any change of the whole population has to considered as well.

So electricity spent in railways is irrelevant to most of the population, as it does not affect the cost of service given by Indian Railways.

Preparing the perfect list is as tough as writing a new constitution, but that should not be any excuse for imperfection.

deepak mitra said...

i understand that both wpi and cpi are calculated considering same basket of goods but with different weightage. am i right

Vinod Kumar said...

Thanks for the post.Your post really gave me a clear idea about inflation Inflation Calculator India