How to Calculate Inflation?
Inflation calculation is very important for any economy. Here we will learn how to calculate inflation? Inflation is calculated by two methods, by calculating changes in price index number (PIN) and by comparing changes in Gross National products (GNP) deflator.
- Price Index Number
- Gross National Products Deflator
1. Price Index Number (PIN)
Index is an indicator or a value of relative study of prices of same commodities over the period of time. Inflation rate can be calculated by taking the percentage change in the price index for a given period of time.
Rate of Inflation = [{PIN Current year – PIN Base year} / PIN Base year] × 100
Where, PIN Current year = Price Index Number for Current year
PIN Base year = Price Index Number for Base year
Base year is the year with which the values from other years are compared.
There are four index method through which we will learn how to calculate inflation?
- Wholesale Price Index (WPI)
- Consumer Price Index (CPI)
- Producer Price Index (PPI)
- Index of Industrial Production (IIP)
1. Producer Price Index (PPI)
Producer Price Index is an index which represents the average changes in price level of basket of selected goods and services at the time of production over the period of time. Producer price index is a measure of inflation based on input costs to producers. Wage inflation (labour wages) and pricing power inflation (costs of raw material) are the reasons for changes in producer price index. Prices are decided on production level.
For calculation of producer price index, year 2017-18 is considered as current base year in India. Basket of selected goods and services have 697 items on which producer price index is calculated.
2. Wholesale Price Index (WPI)
Wholesale price index, name of index itself describes that” Over the period of time, percentage change in price level of basket of selected goods and services in wholesale market at the first point of bulk sale before the retail level” is called wholesale price index. Wholesale means trading of bulk goods and services between business entities before they reach to consumers.
The WPI is published by Department of Economic Adviser in the Ministry of Commerce and Industry.
Frequency of collecting sample for calculation of wholesale price index and publishing the WPI report is weekly.
For calculation of wholesale price index, year 2011-12 is considered as base year in India. Basket of selected goods and services have 697 items on which wholesale price index is calculated.
For calculating the wholesale price index, basket of selected items are divided into three categories.
- Primary articles: These are total 117 items which are bundle of food and non-food items. Primary articles have 20.12% contribution in basket.
- Fuel and power: There are 16 items which includes power generation, coal mining, electricity production, mineral oil and gases, etc. Fuel and power has 14.91% contribution in basket.
- Manufactured Goods: There are 564 items which includes food products, beverages, tobacco products, wood products, textiles, basic metals, alloys, rubber products etc. Manufactured Goods have 64.97% contribution in basket.
3. Consumer Price Index (CPI)
Consumer price index is defined as,” Over the period of time, percentage change in price level of basket of selected goods and services that consumers or households acquire for the purpose of consumption.” Consumer price index is calculated at retail level.
On recommendation of Mr. Urjit Patel in year 2013, WPI was replaced by CPI as a measure indicator of inflation effective from April 2014.
For calculation of consumer price index, year 2012 is considered as base year in India.
The items covered in CPI are divided into eight categories viz. Education, communication, transportation, recreation, apparel, foods and beverages, housing and medical care. The number of items in CPI basket include 448 in rural and 460 in urban.
CPI = (Cost of selected basket in current year / Cost of selected basket in base year) x 100
Now here, very important question arises that India has huge diversity, disparity and significant income inequality then how an ideal or standard CPI can be calculated?
Since the CPI RL/AL does not provide the correct inflation data for the whole population, the Ministry of Statistics and Programme Implementation started compiling new CPI data from 2011. One is called CPI -U for the urban population and the other one is known as CPI -R for the rural population. All these indices are compiled at the States and National levels both.
Here we will understand that, CPI is calculated for consumers, on the basis of worker segmentation. It is divided into four category.
- CPI for Industrial Workers (CPI-IW)
- CPI for Agricultural Labourers (CPI-AL)
- CPI for Rural Labourer (CPI-RL)
- CPI for Urban Non Manual Employee (CPI-UNME)
1. CPI for Industrial Workers (CPI-IW)
“Over the period of time, percentage change in price level of basket of selected goods and services that utilized by average working class industrial workers.” The Labour Bureau compiles the CPI-IW. The Labour Bureau considers 2001 as the base year for CPI-IW calculation.
2. CPI for Agricultural Labourers (CPI-AL)
“Over the period of time, percentage change in price level of basket of selected goods and services that utilized by agricultural labourers.” The Labour Bureau compiles this data to revise minimum wages for agricultural labour in different States. The Labour Bureau considers 1986-87 as the base year for CPI-AL calculation.
3. CPI for Rural Labourer (CPI-RL)
“Over the period of time, percentage change in price level of basket of selected goods and services that utilized by rural labourer.” The Labour Bureau compiles CPI-RL. The Labour Bureau considers 1986-87 as the base year for CPI-RL calculation.
4. CPI for Urban Non Manual Employee (CPI-UNME)
Urban Non Manual Employee means a person whose job involves the use of their mind, rather than the use of their hands or physical strength. For calculation of consumer price index, year 2012 is considered as base year in India.
“Over the period of time, percentage change in price level of basket of selected goods and services that utilized by Urban Non Manual Employee.”
The Central Statistics Office which is now the National Statistical office (NSO) under The Ministry of Statistics and Programme Implementation (MOSPI) calculates the CPI (Rural/Urban/Combined) for the country as a whole and for individual states also.
The Bureau of Labor Statistics (BLS) under the Ministry of Labour and Employment calculates the CPI (AL/RL/IW).
4. Index of Industrial Production (IIP)
Index of Industrial Production is an index which represents the average changes in price of production of basket of selected goods and services at the time of production in industry, over the period of time is called IIP.
For calculation of Index of Industrial Production, year 2011-12 is considered as base year in India. Basket of selected goods and services have 809 items on which Index of Industrial Production is calculated.
2. Gross National Products Deflator
Apart from price index number (PIN), gross national products deflator (GNP-D) is also another method by which we can learn how to calculate inflation?
“Gross Domestic Product Deflator is percentage change in money value of basket of selected goods and services produced with in the geographical boundary of a country, over the period of time.”
The formula used for the calculation of GNP deflator is as follows:
GNP Deflator = (Nominal GNP ÷ Real GNP) * 100
Where Nominal GNP = GNP at current prices
Real GNP = GNP at base year’s prices