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1_awareness+article-9doc - CAclubindia - Interactive Platform for

By Keith Perez,2014-06-26 22:12
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1_awareness+article-9doc - CAclubindia - Interactive Platform for ...

Awareness Article # 9 INFLATION

What is inflation?

Inflation rate of a country is the rate at which prices of goods and services

    increase in its economy. It is an indication of the rise in the general level of

    prices over time. Since it’s practically impossible to find out the average change in prices of all the goods and services traded in an economy (which would give

    comprehensive inflation rate) due to the sheer number of goods and services

    present, a sample set or a basket of goods and services is used to get an

    indicative figure of the change in prices, which we call the inflation rate.

    ? India uses the Wholesale Price Index (WPI) to calculate and then

    decide the inflation rate in the economy.

    ? Most developed countries (UK, US, JAPAN and CHINA) use the Consumer

    Price Index (CPI) to calculate inflation.

What is WPI?

    WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in

    prices of commodities in all trade and transactions. It is also the price index

    which is available on a weekly basis with the shortest possible time lag only two

    weeks. The Indian government has taken WPI as an indicator of the rate of

    inflation in the economy.

What is CPI?

    CPI is a statistical time-series measure of a weighted average of prices of a

    specified set of goods and services purchased by consumers. It is a price

    index that tracks the prices of a specified basket of consumer goods and

    services, providing a measure of inflation.

How WPI is calculated?

    In this method, a set of 435 commodities and their price changes are used for the calculation. The selected commodities are supposed to represent various

    strata of the economy and are supposed to give a comprehensive WPI value for

    the economy.

WPI is calculated on a base year and WPI for the base year is assumed to

    be 100. To show the calculation, let’s assume the base year to be 1970. The

    data of wholesale prices of all the 435 commodities in the base year and the

    time for which WPI is to be calculated is gathered.

    Let's calculate WPI for the year 1980 for a particular commodity, say wheat. Assume that the price of a kilogram of wheat in 1970 = Rs 5.75 and in 1980 =

    Rs 6.10

The WPI of wheat for the year 1980 is,

    (Price of Wheat in 1980 Price of Wheat in 1970)/ Price of Wheat in 1970 x 100

    i.e. (6.10 5.75)/5.75 x 100 = 6.09

Since WPI for the base year is assumed as 100, WPI for 1980 will become 100

    + 6.09 = 106.09.

In this way individual WPI values for the remaining 434 commodities are

    calculated and then the weighted average of individual WPI figures are found

    out to arrive at the overall Wholesale Price Index. Commodities are given

    weight-age depending upon its influence in the economy.

How is Inflation rate calculated?

If we have the WPI values of two time zones, say, beginning and end of year,

    the inflation rate for the year will be,

(WPI of end of year WPI of beginning of year)/WPI of beginning of year x 100

For example, WPI on Jan 1st 1980 is 106.09 and WPI of Jan 1st 1981 is

    109.72 then inflation rate for the year 1981 is,

(109.72 106.09)/106.09 x 100 = 3.42% and we say the inflation rate for the

    year 1981 is 3.42%.

Since WPI figures are available every week, inflation for a particular week is

    calculated based on the above method using WPI on the later week and WPI on

    the previous week. This is how we get weekly inflation rates in India.

    Characteristics of WPI

    Following are the few characteristics of Wholesale Price Index

    1. WPI uses a sample set of 435 commodities for inflation calculation 2. The price from wholesale market is taken for the calculation 3. WPI is available for every week

    4. It has a time lag of two weeks, which means WPI of the week two weeks

    back will be available now.

    Disadvantages of WPI

    Following are the disadvantages of Wholesale Price Index

    1. India is the only major country that uses a wholesale index to measure

    inflation. Most countries use the CPI as a measure of inflation, as this

    actually measures the increase in price that a consumer will ultimately

    have to pay for.

    2. It pointed out that WPI does not properly measure the exact price rise an

    end-consumer will experience because, as the same suggests, it is at the

    wholesale level.

    3. The main problem with WPI calculation is that more than 100 out of the

    435 commodities included in the Index have ceased to be important from

    the consumption point of view.

    4. India constituted the last WPI series of commodities in 1993-94; but has

    not updated it till now that economists argue the Index has lost relevance

    and can not be the barometer to calculate inflation. 5. WPI is supposed to measure impact of prices on business. But India uses

    it to measure the impact on consumers. Many commodities not consumed

    by consumers get calculated in the index. And it does not factor in

    services which have assumed so much importance in the economy.

    Why India is not shifting to CPI ?

    ? In India, there are four different types of CPI indices, and that makes

    switching over to the Index from WPI fairly 'risky and unwieldy.' The four

    CPI series are: CPI Industrial Workers; CPI Urban Non-Manual Employees;

    CPI Agricultural labourers; and CPI Rural labour.

    ? The CPI cannot be used in India because there is too much of a lag in

    reporting CPI numbers.

    ? The WPI is published on a weekly basis and the CPI, on a monthly basis.

    And in India, inflation is calculated on a weekly basis.

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