Inflation Indices and the Common Man 2

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Letter of Transmittal

To,

The Regional Director,

Reserve Bank of India,

Patna (Bihar)

Report of Young Scholar, 2011 on ³Inflation Indices and the Common Man´

Dear sir,

I have great pleasure submitting the report on ³Inflation Indices and the Common

Man´. As the world economy has begun to stabilize in the aftermath of the global crisis,

inflation has re-emerged as a major concern particularly in the fast-recovering

developing economies. Inflation is normally related with high prices which causes

decline in the purchasing power or the value of money. Inflation or inflation rate is

calculated as the percentage change of a certain price index. There are two ways for

calculating inflation rate .They are Consumer Price Index (CPI) and Wholesale Price

Index (WPI). In this project, I have analyzed the measures that are used to calculate the

inflation or inflation rate.

Finally I am very thankful to RESERVE BANK OF INDIA for giving me this rare

opportunity for which I would be highly indebted throughout my life.

Yours sincerely,

K.Satyanarayana

Pintu Kumar Manager (Estate Dept.)

RBI YOUNG SCHOLAR,2011 Guide



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RESERVE BANK OF INDIA

PROJECT REPORT

INFLATION INDICES AND THE COMMON MAN

PREPARED BY-

PINTU KUMAR

RBI YOUNG SCHOLAR

RBI REGIONAL OFFICE, PATNA



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OUR PREAMBLE

to regulate the issue of Bank Note and keeping of reserve

With a view to securing monetary stability in India

And generally to operate the currency and credit

System of the country to its advantage.

-RESERVE BANK OF INDIA



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DECLARATION

I hereby affirm that this project work titled ³Inflation Indices and the Common Man´

carried out by me under the supervision of Shri K.Satyanarayana, Manager (Estate

Department), being submitted to the Reserve Bank of India for the award of the RBI

Young Scholar 2011, is original and has not been submitted either in part or in full to

any other institution or to this institution.

PINTU KUMAR



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PREFACE

Without a sound and effective banking system in India, it cannot have a healthy

economy. The banking system of India should not only be hassle free but it should beable to meet new challenges posed by the technology and any other external and

internal factors.

For the past three decades, India's banking system has several outstanding

achievements to its credit. The most striking is its extensive reach. It is no longer

confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system

has reached even to the remote corners of the country. This is one of the main reasons

of India's growth process.

The government's regular policy for Indian bank since 1969 has paid richdividends with the nationalization of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for

getting a draft or for withdrawing his own money. Today, he has a choice. Gone are

days when the most efficient bank transferred money from one branch to other in two

days. Now it is simple as instant messaging or dials a pizza. Money has become the

order of the day.

Banking in India originated in the last decades of the 18th century. The oldest

bank in existence in India is the State Bank of India, a government-owned bank that

traces its origins back to June 1806 and that is the largest commercial bank in the

country. Central banking is the responsibility of the Reserve Bank of India, which in

1935 formally took over these responsibilities from the then Imperial Bank of India,

relegating it to commercial banking functions. After India's independence in 1947, the

Reserve Bank was nationalized and given broader powers. In 1969 the government

nationalized the 14 largest commercial banks; the government nationalized the six next

largest in 1980.



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ACKNOWLEDGEMENT

First of all I would like to thank Reserve bank of India to allow me to be a part of

such a reputed institution, the Apex Bank of India, which gave me the chance to work

on the project titled ³INFLATION INDICES AND THE COMMON MAN´. I sincerely

thank the Governor of Reserve Bank of India and Shri Mohit Kumar Singh, Regional

Director Patna and Jharkhand office for facilitating and providing an opportunity to learn

in the form of a training programme.I further thank Shri Suramya Mohan, AGM (RPCD)

for helping me in the project along with RBI.

A special acknowledgement goes to Shri K.Satyanarayana, Manager (Estate

Department) for helping me to understand the various aspects related to Inflation and

guiding me to undertake the project in the right direction. He further helped me to collect

data and information related to my topic and also helped me to analyze it and give it a

proper shape.

I am also thankful to Department of Administration and Personnel Management

(DAPM), for guidance and hospitality provided throughout the period of the internship. In

particular, I would like to thank Shri Praveen Kumar (DAPM), Manager and Shri K. S.

Gauri (DAPM) , Assistant Manager for their encouragement and guidance. Without their

friendly and moral support, this project would have never been easier and a joyful and

memorable learning.

No amount of thank giving¶s would compensate the constant help andencouragement received from Shri Ashwani Kumar Dixit, Assistant Manager (DIT) and

whole DIT cell for computer assistance.

I am also thankful to my colleagues Abhishek Kumar Singh, Abhinav Krishna,

Jitendra Kumar, Rameshwar Dayal Lodi and Niyati Kumari for their encouragement and

support to utilize this opportunity.

Finally I once again thank RESERVE BANK OF INDIA for giving me this rare

opportunity to study under RBI YOUNG SCHOLAR AWARD SCHEME 2011 for which I

would be highly indebted throughout my life.

PINTU KUMAR



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SYNOPSIS

Title: Inflation Indices and the common man

In economics inflation is a rise in the general level of prices of goods and servicesin an economy over a period. When the general price level rises, each unit of currency

buys fewer goods and services. Consequently, inflation also reflects erosion in the

purchasing power of money ± a loss of real value in the internal medium of exchange

and unit of account in the economy. A chief measure of price inflation is the inflation rate

the annualized percentage change in a general price index.

Inflation or inflation rate is calculated as the percentage change of a certain price

index. There are two ways for calculating inflation rate .They are Consumer Price Index

(CPI) and Wholesale Price Index (WPI). A consumer price index measures changes in

the price level of consumer goods and services purchased by households. It is a priceindex that tracks the prices of a specified basket of consumer goods and services,

providing a measure of inflation. CPI is a fixed quantity price index and considered by

some a cost of living index. Under CPI, an index is scaled so that it is equal to 100 at a

chosen point in time, so that all other values of the index are a percentage relative to

this one. CPI is used by many countries to calculate inflation such as USA, UK, Japan,

France etc.

Wholesale price index 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 676

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. Currently the base year on which inflation is calculated is 2004-05.

Inflation's effects on an economy are various and can be simultaneously

positive and negative. Negative effects of inflation include a decrease in the real value

of money and other monetary items over time, uncertainty over future inflation may

discourage investment and savings, and high inflation may lead to shortages of goods if

consumers begin hoarding out of concern that prices will increase in the future. Positive

effects include ensuring central banks can adjust nominal interest rates (intended to

mitigate recessions), and encouraging investment in non-monetary capital projects.

Economists generally agree that high rates of inflation and hyperinflation are

caused by an excessive growth of the money supply. Views on which factors determine



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low to moderate rates of inflation are more varied. Low or moderate inflation may be

attributed to fluctuations in real demand for goods and services, or changes in available

supplies such as during scarcities, as well as to growth in the money supply. However,

the consensus view is that a long sustained period of inflation is caused by money

supply growing faster than the rate of economic growth.

Today, most mainstream economists favour a low, steady rate of inflation. Low

(as opposed to zero or negative) inflation may reduce the severity of economic

recessions by enabling the labor market to adjust more quickly in a downturn, and

reduce the risk that a liquidity trap prevents monetary policy from stabilizing the

economy. The task of keeping the rate of inflation low and stable is usually given to

monetary authorities. Generally, these monetary authorities are the central banks that

control the size of the money supply through the setting of interest rates, through open

market operations, and through the setting of banking reserve requirements.

So in order to highlight how inflation affects the common man and his living I am

working on ³Inflation indices and the common man´.



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CONTENTS

SI.NO. SUBJE

CTSP

AGE

NO. 1 Introduction of RBI 1

2 History of Inflation 23 Meaning ,definition and features 3

4 Causes of Inflation(a) Factors affecting Demand 4

(b) Factors affecting Supply 6

5 Measures to control Inflation 86 Types of Inflation 11

7 Inflation Indices(a)Wholesale Price Index(WPI) 12

(b)Commodities along with their weightage in WPI 14(c)Limitations of WPI 15

(d)Consumer Price Index 15

(e)Commodities along with their weightage in CPI 16(f)CPI vs. WPI 17

8 Effects of Inflation on different Income Groups 189 Recommendations 19

10 Conclusion 20

11 Bibliography 21



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INTRODUCTION OF RBI

(THE CENTRAL BANK OF INDIA)

The central bank of the country is the Reserve Bank of India (RBI). The

Reserve Bank of India was established on April 1, 1935 in accordance with the

provisions of THE RESERVE BANK OF INDIA ACT, 1934. Though originally

privately owned, since nationalization in 1949, the Reserve Bank is fully owned by

the Government of India. The Central Office of the Reserve Bank has been in

Mumbai since inception. The Central Office is where the Governor sits and is where

policies are formulated. Now it has 22 regional offices, most of them in state capitals.

The Bank was constituted for the need of following:

y To regulate the issue of banknotes.

y To maintain reserves with a view to securing monetary stability.y To operate the credit and currency system of the country to its advantage.

FUNCTIONS

y Banker to the government.

y Banker¶s bank.

y Lender of the last resort.

y Custodian of foreign reserves.

y Regulator and Supervisor of the financial system.

y Manager of exchange control

y Issue of currency



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INFLATION

HISTOR Y

Increase in the quantity of money or in the overall money supply (or debasement of

the means of exchange) has occurred in many different societies throughout history,

changing with different forms of money used. For instance, when gold was used as

currency, the government could collect gold coins, melt them down, mix them with other

metals such as silver, copper or lead, and reissue them at the same nominal value. By

diluting the gold with other metals, the government could issue more coins without also

needing to increase the amount of gold used to make them. When the cost of each coin

is lowered in this way, the government profits from an increase in seigniorage. This

practice would increase the money supply but at the same time the relative value of each coin would be lowered. As the relative value of the coins becomes less,

consumers would need to give more coins in exchange for the same goods and

services as before. These goods and services would experience a price increase as the

value of each coin is reduced.

Historically, infusions of gold or silver into an economy have also led to inflation.

From the second half of the 15th century to the first half of the 17th, Western Europe

experienced a major inflationary cycle referred to as the "price revolution´, with prices

on average rising perhaps six fold over 150 years. This was largely caused by the

sudden influx of gold and silver from the New World into Habsburg Spain. The silver spread throughout a previously cash starved Europe, and caused widespread inflation.

By the nineteenth century, economists categorized three separate factors that

cause good, a change in the price of money which then was usually a fluctuation in the

commodity price of the metallic content in the currency, and currency depreciation

resulting from an increased supply of currency relative to the quantity of redeemable

metal backing the currency. Following the proliferation of private bank note currency

printed during the American Civil War, the term "inflation" started to appear as a direct

reference to the currency depreciation that occurred as the quantity of redeemable bank

notes outstripped the quantity of metal available for their redemption. The term inflation

then referred to the devaluation of the currency, and not to a rise in the price of goods.



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Meaning and Definition

Inflation is normally related with high prices which causes decline in the purchasing

power or the value of money. Inflation refers to the substantial and rapid increase in the

general price level. It is primarily a monetary phenomenon. Prices keep on rising due to

excess supply of money and lower production of exchangeable goods.

According to Crowther , ³Inflation is a state in which the value of money is falling, i.e.,

prices are rising. ³

According to Pigou, ³Inflation takes place when money income is expanding relatively

to the output of work done by the productive agents for whom it is the payment.´

Features

(1) The quantity of money is increasing but the production is static and increasing.

(2) The quantity of money is stable but the production is declining.

(3) If the quantity of money is declining and the production is also declining but

decline of production is higher than the decline in quantity of money.

(4) If the quantity of money is increasing and the volume of production is declining.

(5) If the quantity of money is in excess of demand or requirements.

(6) If the quantity of money as well as production is increasing but the rate of increase in

production is lesser than the rate of increase in the quantity of money.



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CAUSES OF INFLATION

Inflation is caused when the aggregate demand exceeds the aggregate supply

of goods and services. We analyze the factors which lead to increase in demand and

the shortage of supply.

Factors Affecting Demand

Both Keynesians and monetarists believe that inflation is caused by increase in the

aggregate demand. They point towards the following factors which raise it.

(1) Increase in money supply

Inflation is caused by an increase in the supply of money which leads to

increase in aggregate demand. The higher the growth rate of the nominal money

supply, the higher is the rate of inflation.

(2) Increase in Disposable Income

When the disposable income of the people increases, it raises their demand for goods and services. Disposable income may increase with the rise in national

income or reduction in taxes or reduction in the saving of the people.

(3) Increase in Government Expenditure

Government activities have been expanding much with the result that

government expenditure has also been increasing at a phenomenal rate, thereby

raising aggregate demand for goods and services. Governments of bothdeveloped and developing countries are providing more facilities under public

utilities and social services, and also nationalizing industries and starting public

enterprises with the result that they help in increasing aggregate demand.



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(4) Increase in Consumer Spending

The demand for goods and services increases when consumer expenditure

increases. Consumers may spend more due to conspicuous consumption or

demonstration effect. They may also spend more when they are given credit

facilities to buy goods on hire-purchase and installment basis.

(5) Cheap Monetary Policy

Cheap monetary policy or the policy of credit expansion also leads to increase in

the money supply which raises the demand for goods and services in the

economy. When credit expands, it raises the money income of the borrowers

which, in turn, raises aggregate demand relative to supply, thereby leading to

inflation. This is also known as credit-induced inflation.

(6) Deficit Financing

Deficit financing means spending more than revenue. In this case government of

India accepts more amount of money from the Reserve Bank India (RBI) to spend

for undertaking public projects and only the government of India can practice deficit

financing in India. The high doses of deficit financing which may cause reckless

spending, may also contribute to the growth of the inflationary spiral in a country. This is also known as deficit- induced inflation.

(7) Expansion of the Private Sector

The expansion of the private sector also tends to raise the aggregate demand.

For huge investments increase employment arid income, thereby creating more

demand for goods and services. But it takes time for the output to enter the

market.

(8) Black Money

It is widely condemned that black money in the hands of tax evaders and black

marketers as an important source of inflation in a country. Black money encourages

lavish spending, which causes excess demand and a rise in prices.



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(9) Repayment of Public Debt

Whenever the government repays its past internal debt to the public, it leads to

increase in the money supply with the public. This tends to raise the aggregate

demand for goods and services. These, in turn, create more demand for goods and services within the economy.

Factors Affecting Supply

There are also certain factors which operate on the opposite side and tend to

reduce the aggregate supply. Some of the factors are as follows:

(1) Shortage of Factors of Production

One of the important causes affecting the supplies of goods is the shortage

of such factors as labor, raw materials, power supply, capital etc. They lead

to excess capacity and reduction in industrial production.

(2) Industrial Dispute

In countries where trade unions are powerful, they also help in curtailing

production. Trade unions resort to strikes and if they happen to be

unreasonable from the employers' viewpoint and are prolonged, they force

the employers to declare lock-outs. In both cases, industrial production falls,

thereby reducing supplies of goods. If the unions succeed in raising money

wages of their members to a very high level than the productivity of labor,

this also tends to reduce production and supplies of goods.

(3) Natural Calamities

Drought or floods is a factor which adversely affects the supplies of

agricultural products. The latter, in turn, create shortages of food products

and raw materials, thereby helping inflationary pressures.



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(4) Artificial Scarcities

Artificial scarcities are created by hoarders and speculators who indulge in

black marketing. Thus they are instrumental in reducing supplies of goodsand raising their prices.

(5) Increase in Exports

When the country produces more goods for export than for domestic

consumption, this creates shortages of goods in the domestic market. This

leads to inflation in the economy.

(6) Lop-Sided Production

If the stress is on the production of comfort, luxuries, or basic products to

the neglect of essential consumer goods in the country, this creates

shortages of consumer goods. This again causes inflation.

(7) Law of Diminishing Returns

If industries in the country are using old machines and outmoded methods

of production, the law of diminishing returns operates. This raises cost per

unit of production, thereby raising the prices of products.

(8) International Factors

In modern times, inflation is a worldwide phenomenon. When prices rise in

major industrial countries, their effects spread to almost all countries with

which they have trade relations. Often the rise in the price of a basic raw

material like petrol in the international market leads to rise in the price of all

related commodities in a country.



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MEASURES TO CONTROL INFLATION

Inflation can be controlled by increasing the supplies and reducing money

incomes in order to control aggregate demand. The various methods are usually

grouped under three heads: Monetary measures, fiscal measures and other measures.

Monetary Measures

Monetary measures aim at reducing money incomes.

(a) Monetary Policy:- One of the important monetary measures is monetary

policy. The central bank of the country adopts a number of methods to control

the quantity and quality of credit. For this purpose, it sells securities in the openmarket, raises the reserve ratio, and adopts a number of selective credit control

measures, such as raising margin requirements and regulating consumer credit.

Monetary policy may not be effective in controlling inflation, if inflation is due to

cost-push factors. Monetary policy can only be helpful in controlling inflation

due to demand-pull factors.

(b) Demonetization of Currency: - However, one of the monetary measures is

to demonetize currency of higher denominations. Such a measure is usually

adopted when there is abundance of black money in the country.

(c) Issue of new currency:- The most extreme monetary measure is the issue

of new currency in place of the old currency. Under this system, one new note is

exchanged for a number of notes of the old currency. The value of bank deposits

is also fixed accordingly. Such a measure is adopted when there is an excessive

issue of notes and there is hyperinflation in the country. It is very effective measure.

But is inequitable for its hurts the small depositors the most.



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Fiscal Policy

Monetary policy alone is incapable of controlling inflation. It should, therefore, be

supplemented by fiscal measures. Fiscal measures are highly effective for controlling

government expenditure, personal consumption expenditure, and private and public

investment. The principal fiscal measures are the following:

(a) Reduction in unnecessary expenditure:- The government should reduce

unnecessary expenditure on non-development activities in order to curb inflation. This

will also put a check on private expenditure which is dependent upon government

demand for goods and services. But it is not easy to cut government expenditure.

Though economy measures are always welcome but it becomes difficult to distinguish

between essential and non-essential expenditure. Therefore, this measure should be

supplemented by taxation.

(b) Increase in taxes:- To cut personal consumption expenditure, the rates of personal,

corporate and commodity taxes should be raised and even new taxes should be levied,

but the rates of taxes should not be so high as to discourage saving, investment and

production. Rather, the tax system should provide larger incentives to those who save,

invest and produce more. Further, to bring more revenue into the tax-net, the

government should penalize the tax evaders by imposing heavy fines. Such measures

are bound to be effective in controlling inflation. To increase the supply of goods within

the country, the government should reduce import duties and increase export duties.

(c) Increase in savings:- Another measure is to increase savings on the part of thepeople. This will tend to reduce disposable income with the people, and hence personal

consumption expenditure. But due to the rising cost of living, people are not in a position

to save much voluntarily. Keynes, therefore, advocated compulsory savings or what he

called µdeferred payment' where the saver gets his money back after some years. For

this purpose, the government should float public loans carrying high rates of interest,

start saving schemes with prize money, or lottery for long periods, etc. It should also

introduce compulsory provident fund, provident fund-cum-pension schemes, etc.

compulsorily. All such measures to increase savings are likely to be effective in

controlling inflation.

(d) Surplus Budget:- An important measure is to adopt anti-inflationary budgetary

policy. For this purpose, the government should give up deficit financing and instead

have surplus budgets. It means collecting more in revenues and spending less.

(e) Public Debt:- At the same time, it should stop repayment of public debt and

postpone it to some future date till inflationary pressures are controlled within the



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economy. Instead, the government should borrow more to reduce money supply with

the public.

Like the monetary measures, fiscal measures alone cannot help in controlling

inflation. They should be supplemented by monetary, non-monetary and non fiscal

measures.

Other Measures

The other types of measures are those which aim at increasing aggregate supply

and reducing aggregate demand directly.

(a) To Increase Production:- The following measures should be adopted to increase

production:

(i) One of the foremost measures to control inflation is to increase the production of

essential consumer goods like food, clothing, kerosene oil, sugar, vegetable oils, etc.

(ii) If there is need, raw materials for such products may be imported on preferential

basis to increase the production of essential commodities.

(iii) Efforts should also be made to increase productivity. For this purpose, industrial

peace should be maintained through agreements with trade unions, binding them not to

resort to strikes for some time.

(iv) The policy of rationalization of industries should be adopted as a long-term

measure. Rationalization increases productivity and production of industries through the

use of brain, brawn and bullion.

(v) All possible help in the form of latest technology, raw materials, financial help,

subsidies, etc. should be provided to different consumer goods sectors to increase

production.

(b) Rational Wage Policy :- Another important measure is to adopt a rational wageand income policy. Under hyperinflation, there is a wage-price spiral. To control this, the

government should freeze wages, incomes, profits, dividends, bonus, etc. But such a

drastic measure can only be adopted for a short period and by antagonizing both

workers and industrialists. Therefore, the best course is to link increase in wages to

increase in productivity. This will have a dual effect. It will control wage and at the same

time increase productivity, and hence production of goods in the economy.



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(c) Price Control:- Price control and rationing is another measure of direct control to

check inflation. Price control means fixing an upper limit for the prices of essential

consumer goods. They are the maximum prices fixed by law and anybody charging

more than these prices is punished by law. But it is difficult to administer price control.

(d) Rationing:- Rationing aims at distributing consumption of scarce goods so as to

make them available to a large number of consumers. It is applied to essential

consumer goods such as wheat, rice, sugar, kerosene oil, etc. It is meant to stabilize the

prices of necessaries and assure distributive justice. But it is very inconvenient for

consumers because it leads to queues, artificial shortages, corruption and black

marketing. Keynes did not favour rationing for it "involves a great deal of waste, both of

resources and of employment."

TYPES OF INFLATION

Demand-Pull Inflation:- This type of inflation occurs when total demand for goods and

services in an economy exceeds the supply of the same. When the supply is less, the

prices of these goods and services would rise, leading to a situation called as demand-

pull inflation. This type of inflation affects the market economy adversely during the

wartime.

Cost-Push Inflation:- As the name suggests, if there is increase in the cost of

production of goods and services, there is likely to be a forceful increase in the prices of

finished goods and services. This type of inflation may or may not occur in conjunction

with demand-pull inflation.

Hyper Inflation:- It is an extremely accelerated form of inflation, occurring when the

country imposing it is in desperate need of money-either to pay debts, fund

development and so on.

Stagflation:- This is the situation in which the inflation continues to rise although the

economy is in recession. This type of inflation can have disastrous effects but isgenerally a short lived form of inflation as it could potentially lead to a financial crisis.



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INFLATION INDICES

Inflation rate 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.

Mathematically, inflation or inflation rate is calculated as the percentage rate of change

of a certain price index. These indices are Wholesale Price Index and Consumer PriceIndex.

Wholesale Price Index

WPI was first published in 1902, and was one of the more economic indicators

available to policy makers until it was replaced by most developed countries by the

Consumer Price Index in the 1970s. 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 totalof 676 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.

Inflation rate in India from 2008 to 2011



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Criteria for selection of Wholesale Price Outlets The following criteria were used to determine the wholesale price outlets:

(1) Popularity of an establishment along the line of goods to be priced

(2) Consistency of the stock

(3) Permanency of the outlet

(4) Cooperativeness of the price informant

(5) Location Criteria for selection of commodities in the Market Basket The commodities in the market basket were selected according to the following criteria:

(1) Popularity of the variety of the commodity (implies representativeness with respect

to the commodity)

(2) Consistency of supply in the market (sustained availability of supply from the base

period to the present)

(3) Relatively high market share of the commodity.

Calculation of inflation rate by WPI

In this method, a set of 676 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 676 commodities in the base year and the time for which WPI is to becalculated 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 arecalculated and then the weighted average of individual WPI figures are found out to

arrive at the overall Wholesale Price Index. Commodities are given weightage

depending upon its influence in the economy.

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

inflation rate for the year will be,



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(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 the inflation rate for the year 1981 is

3.42%(APPROX.)

This is how we calculate the inflation rate of a period by using the Wholesale

price index.

Commodities along with their weightage in WPI

S.NO. Commodities Weightage

1 Primary Articles:

(a) Food Articles 14.34(b) Non-Food Articles 4.25

(c) Minerals 1.53Sub Total 20.12

2 Fuel, Power, Light & Lubricants

(a) Coal Mining 2.09(b) Mineral Oils 9.36

(c) Electricity 3.46

Sub Total 14.913 Manufactured Products

(a) Food Products 9.97

(b) Beverages, Tobacco and Tobacco Products 1.76

(c) Textiles 7.33

(d) Wood and Wood Products 0.58

(e) Paper and Paper Products 2.04(f) Leather and Leather Products 0.84

(g) Rubber and Plastic Products 2.99

(h) Chemicals and Chemical Products 12.02

(i) Non-Metallic Mineral Products 2.55

(j) Machinery and Machine Tools 8.93(k) Transport Equipment and Parts 5.21

(l) Basic Metals and Alloys 10.75Sub Total 64.97

GRAND TOTAL 100.00

Source: The Office of the Economic Advisor, Ministry of Commerce and Industry



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Limitations of WPI

(1)WPI does not include services while they are the most essential part of an economy.

(2)WPI follows a fixed weightage of all the commodities while the economy is

undergoing many structural changes.

(3)The base year is chosen after a decade which is a very long time.

(4)The inflation rate is measured at the ³Intermediate demand level´ and not at the

³Final demand level´.

(5) Another problem is that the share of expenditure of commodities may change

overtime. For instance, the expenditure on computers, which were seldom available

before 1990s but now have a significant share in the expenditure of an urban Indian. So

the weights of these indices need to be changed over time.

Consumer Price Index

A Consumer Price Index (CPI) measures changes in the price level of consumer

goods and services purchased by households. The CPI is defined by the United States

Bureau of Labor Statistics as "a measure of the average change over time in the prices

paid by urban consumers for a market basket of consumer goods and services.´

The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. Sub-indexes and sub-sub-

indexes are computed for different categories and sub-categories of goods and

services, being combined to produce the overall index with weights reflecting their

shares in the total of the consumer expenditures covered by the index. CPI is a fixed

quantity price index and considered by some a cost of living index. Under CPI, an index

is scaled so that it is equal to 100 at a chosen point in time, so that all other values of

the index are a percentage relative to this one.

It is one of several price indices calculated by most national statistical agencies.

The annual percentage change in a CPI is used as a measure of inflation. A CPI can beused to index (i.e., adjust for the effect of inflation) the real value of wages, salaries,

pensions, for regulating prices and for deflating monetary magnitudes to show changes

in real values. In most countries, the CPI is, along with the population census and the

USA National Income and Product Accounts one of the most closely watched national

economic statistics.



25

Calculation of inflation rate by CPI

CPI of current year- CPI of previous year/CPI of previous year ×100

Let CPI number of current year be 196.8 and of previous year be 190.3; Then

Inflation Rate = 196.8 ± 190.3 / 190.3 × 100

= 6.5 / 190.3 × 100

= 3.4 %

Commodities along with their weightage in CPI

SI.NO. Commodities Weightage

1 Food and Beverages 14.59

2 Housing 42.0743 Apparel, Textile and Footwear 3.772

4 Transport 17.199

5 Recreation and Entertainment 6.625

6 Education and Communication 6.288

7 Medical care 6.2948 Other goods and services 3.229

Grand Total 100.00

Source: United States Department of Labor-MAY 2011



26

CPI vs. WPI

(1) WPI does not properly measure the exact price an end-consumer will experience

because it is at the wholesale level, whereas, CPI actually measures the increase in

price that a consumer will ultimately have to pay for.

(2) Many commodities included in WPI have ceased to be important from the consumer

point of view, whereas, CPI commodities are changed as the consumption pattern

follows.

(3) In CPI, the commodity basket is reviewed after every 4-5 years which is not in the

case of WPI.

(4) The WPI doesn¶t take the price of services into consideration, which now accounts

for 60 percent of the GDP. Also, it is too general and cannot be used for specific

purposes. For example, if an individual wants to know the trends in office stationery

products, then WPI may not capture the correct or complete picture.

(5) The WPI is compiled and published by Office of the Economic Advisor on a weekly

basis while the CPI is compiled and published by the Labour Bureau on a monthly basis

in India. The CPI is published for rural, agricultural and industrial workers.

(6) Wholesale price index measures inflation at each stage of production whileConsumer price index measures inflation only at final stage of production.

(7) Wholesale price index is the middle point of the sum of all the goods bought by the

traders whereas consumer price index is the middle point of the sum of all the goodsbought by consumers.

(8) There are only few countries that use WPI to calculate inflation rates whereas manynations have already shifted to using CPI.

(9) WPI is said to result an erroneous measure while CPI will describe actual cost of living and inflation rate more accurately.



27

Effects of Inflation on different income groups

(1) Wage and Salary Earners:- Wage and Salary Earners suffer a lot during inflation

because wages and salaries generally do not rise in the same proportion in which thecost of living rises. For example, the National Floor Level of Minimum Wage has

increased from Rs.80 to Rs.115 per day during the last 4-5 years but the inflation rate

during this period rose from 6.39% to 9.04%.So there is a time lag between these two. If

the workers and salary earners are well organized into power trade-unions, they may

not suffer much during inflation but if they are unorganized, they suffer very deeply.

(2) Pensioned-Income Groups:- These groups have the hardest hit as their incomes

are fixed which do not bear any relationship with the rising cost of living. They have tocut- off the consumption of some essential daily use products in order to meet up the

hike in prices.

(3) Entrepreneurs:- Inflation is welcomed by entrepreneurs and businessmen because

they stand to profit by rising prices. They find that the value of their inventories and

stock of goods is rising in money terms. They also find that prices are rising faster than

the costs of production, so that their profit is greatly enhanced.

(4) Farmers:- Farmers are generally the gainers during inflation. The prices of farm

products go up while the costs incurred by them do not go up to the same extent. But

there is a time-lag between rise in prices and the increase in costs. In this, the big

farmers who have huge investment earn more than the small farmers whose turnover is

low.

(5) Investors:- Those who invest in debentures and fixed-interest bearing securities,

bonds, etc, lose during inflation. However, investors in equities benefit because more

dividend is yielded on account of high profit made by joint-stock companies during

inflation.



28

RECOMMENDATIONS

The Reserve Bank of India should review the commodity basket of WPI after

every three years and not after a decade. This will cover up all the structural andrecent changes in the consumption pattern.

The base year to be used should not include any abnormal changes, price

fluctuations etc.

The Reserve Bank of India should increase the reserve requirements of the

demand deposits, the commercial banks shall now be required to keep larger

reserves with the RBI and to that extent their power to create credit shall become

limited but during this they should keep in view the growth rate of the country.

We have poor infrastructure. If infrastructure improves, the cost of goods and

services comes down. We need to quickly build highways, power plants and

ports. For this purpose, the government should allow infrastructure companies to

float tax-free infrastructure bonds.

The government should discourage the export of those goods particularly whose

prices are rising at an alarming rate and are also not available in the domestic

market for consumption and not only this but also encourage their import from

the foreign countries.

The government should take measures to introduce farm sector reforms as a

priority. This may include use of technology in farming, use of high yielding

variety seeds, non dependence on monsoon etc. This will boost the overall farm

productivity with higher yields and reduced costs. As a result, this may bring

down the prices of essential products and in turn having a positive effect on

efforts to bring down the inflation.

Credit to agricultural sector should be made more target oriented in order to bring

down the input costs. Measures to cover crop failures due to drought conditions,

floods etc should be linked along with agricultural credit.



29

CONCLUSION

As the world economy has begun to stabilize in the aftermath of the global crisis,

inflation has re-emerged as a major concern particularly in the fast-recoveringdeveloping economies. At present, the major pressure on prices is emanating from the

food and energy sectors both at global and domestic levels. However, it has now also

advanced towards the core sector.

The Reserve Bank of India is trying to control inflation supportive of growth

momentum. This has to be seen in the context of more than expected inflation in the

recent past, relative stickiness of prices, especially of food and building of wider

inflationary expectations in the economy even as monetary policy tools are being used

proactively to manage demand and damper inflationary pressures in the economy.

Inflation has been elevated for over a year and RBI has responded by raising the reporate, or the rate at which it lends to banks, ten times. It has tried to bring down the

aggregate demand. Lower demand acts a check on rising prices. Inflationary pressures

in the economy are also emanating in part from supply-side constraints, especially in

food and other primary articles, as well as the transmission of higher global food, oil and

other commodity prices. These considerations therefore are complicating the issue in

the near term.

Therefore, it is important for the Reserve Bank of India to ensure a low

inflation environment as a pre-condition for sustained high growth.



BIBLIOGRAPHY

1. www.rbi.org

2. www.wikipedia.com

3. The Economic Times4. Money and Banking M. L. Seth

5. Economic Survey of Delhi 200 5-2006

6. Economic Survey 20 10 -20 11

7 . United States Department of Labor

8 . SME Times

9. livemint .com

10 . The Finance Blog

11. Business Advice Forum

12. General Knowledge Today

13.Trading Economics.com; Indian Ministry of Labour

Documents

Inflation Indices and the Common Man 2