All You Want To Know About Inflation

In news papers, television, magazines you read about inflation almost every day but have you ever wondered what inflation is and how you get an inflation rate. Inflation in simple words is a general increase in price. In economics inflation is defined as the rate at which the general level of prices of goods and services rise and subsequently the purchasing power falls over a period of time.

As the inflation rises every dollar will buy smaller percentage of goods. For example if inflation rate is 2% then a 1$ pack of good will cost $1.02 in a year. Central banks attempt to stop severe inflation along with severe deflation in order to maintain excessive growth in prices of goods to a minimum. Deflation is defined as a general decline in prices due to a reduction in supply of money or credit. Central banks of most of the countries try to sustain an inflation rate of 2 to 3 percent.

Mathematically inflation rate is calculated as the percentage rate of change of a certain price index. In India the inflation rate is calculated using wholesale price index. In India it is calculated on a weekly basis. WPI is defined as an index that is used to measure the changes in the average price of goods and services that are traded in the wholesale market of India. In WPI a total of 435 commodities data on price level is tracked. The shortest possible time lag in WPI is two weeks. WPI was first published in 1902 but it was replaced by most of the countries in 1970 by consumer price index. The Indian government has taken WPI as an indicator of inflation rate in the Indian economy.

Wholesale price index characteristics:

1.     It uses a set of 435 commodities for inflation calculation.

2.     Price from wholesale market is taken.

3.     WPI is available on weekly basis.

4.     It has a time lag of two weeks i.e. WPI of the week two weeks back will be available now.

How to calculate WPI?

Let us calculate WPI for the year 2000 for a commodity, say soya bean. If the price of one kilogram soya bean in 1990 =5.75and in 2000 =6.25.

The WPI of soya bean for the year 2000 is

(Price of soya bean in the year 2000-price of soya bean in the year 1990)/price of 1990x 100

i.e. (6.25-5.75)/5.75×100=8.69

Since the WPI for the base year is assumed as 100, WPI for 2000 will become 100+8.69=108.69.

Likewise the WPI of remaining 434 commodities is calculated then the weighted average of individual WPI figures are found out to arrive at the overall wholesale price index. The weight-age is given to commodities depending upon the influence in the economy.

How to calculate inflation rate?

If we have WPI of two time zones for example WPI of the beginning and end of the year then the inflation rate for the year will be:

(WPI of the end of the year- WPI of the beginning of the year)/ WPI of beginning of the yearx100

For example, if the WPI on 1st Jan 2000 is 108.69 and WPI on 1st Jan 2001 is 110.75 then the inflation rate for the year 2001 will be:

(110.75-108.69)/108.69×100=1.9%

Inflation for a particular week is calculated based on the above method using WPI of the given week and WPI of the week one year before.

The last reported inflation rate in India in June 2010 was 13.73%.

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