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What is inflation?

We often hear people talking about the rising prices and how they could buy more things earlier with the same amount of money. Containing inflation is also one of the prime goals of every government. But what is inflation?

What is inflation?

Inflation is a sustained / persistent rise in the general level of prices of (most of) the goods and services in the economy.

Why the prices rise?

The rise in prices is generally caused due to mismatch in the demand and supply of goods and services. Depending on the source / reason of the price rise, the inflation is categorised as –

  1. Demand-pull inflation
  2. Cost-push inflation

Demand-pull inflation

When the demand for goods and services is more than its supply, it creates an upward pressure on the prices. Such inflation is known as demand-pull inflation. The factors such as increasing population, rise in income levels, increase in money supply and liquidity in the economy, etc. lead to higher demand for goods and services. 

The central bank of a country plays an important role in managing the demand-pull inflation through its monetary policy by influencing the money supply and liquidity in the economy, thereby affecting the aggregate demand. 

Cost-push inflation

When the rise in prices is due to the supply side factors such as rise in cost of production, supply side disruptions, etc. it is known as cost-push inflation. 

The management of cost-push inflation needs intervention of the government through its fiscal policy measures like reducing taxes, providing subsidies, increasing supply through imports, ensuring smooth flow of supply chain, taking measures to increase production, etc. 

How is inflation measured in India?

In India, the inflation is measured by –

  1. Consumer Price Index (CPI)
  2. Wholesale Price Index (WPI) 

Consumer Price Index (CPI)

Consumer Price Index (CPI) measures the inflation in terms of retail prices of various goods and services. The National Statistical Office (NSO), Ministry of Statistics and Programme Implementation (MoSPI), Government of India, releases CPI numbers in India (Base Year: 2012).

Sub-indices of CPI –

  1. CPI-Combined (base year 2012)
  2. CPI-Rural (base year 2012)
  3. CPI-Urban (base year 2012)
  4. CPI-Industrial Workers (IW) (base year 2001)
  5. CPI-Agricultural Labourers (base year 1986-87)
  6. CPI-Rural Labourers (base year 1986-87)

Constituents of CPI-Combined –

Constituent Weight
Food and beverages 45.86%
Pan, tobacco and intoxicants 2.38%
Clothing and footwear 6.53%
Housing 10.07%
Fuel and light 6.84%
Miscellaneous 28.32%

Wholesale Price Index (WPI) 

Wholesale Price Index (WPI) measures the inflation in terms of wholesale prices of various goods and services. The Office of the Economic Adviser, Department for Promotion of Industry and Internal Trade (DPIIT), Government of India, releases WPI numbers in India (Base Year: 2011-12). Provisional figures of WPI for a month are released on the 14th (or next working day) of the next month and compiled with data received from institutional sources and selected manufacturing units across the country. After 10 weeks, the index is finalized, and final figures are released and then frozen thereafter.

Constituents of WPI –

Constituent Weight
Primary Articles 22.62%
Fuel & Power 13.15%
Manufactured Products 64.23%
Food Index 24.38%

Is inflation good?

It is said that a reasonable rise in prices is good for the economy as it provides an incentive to the producers to produce more, leading to more production and income in the economy. The increased income also enables people to bear the rise in prices. However, if the rate of increase in prices is more than the rate of rise in incomes, it begins to hurt. Also, the uncertainty caused by rapid rise in prices results in producers postponing their investment and production decision, thereby adversely affecting the economy.

What are the commonly used inflation terminologies?

  • Headline inflation – general rise in prices of goods and services for eg. CPI-Combined and WPI
  • Core inflation – general rise in prices of goods and services excluding that of food and energy
  • Food inflation – increase in food prices
  • Sticky inflation – a situation of high inflation and stagnant growth
  • Shrinkflation – where the price of a unit of a product remains the same, however, the quantity / weight of the unit reduces
  • Hyper / runaway inflation – very rapid rise in prices
  • Galloping / hopping inflation – prices increasing in arithmetic or geometric progression
  • Creeping inflation – slow / gradual increase in prices 
  • Dis-inflation / Deflation – fall in prices and rise in unemployment
  • Stagflation – a situation of rising both inflation and unemployment, and low growth

What is inflation spiral?

Inflation spiral is a situation where the rise in prices results in demand for higher wages, resulting in increased cost of production and rise in prices (cost-push inflation), further leading to demand for higher wages.

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