Inflation is a critical measure of the economy’s health. Rising inflation makes products and services pricy and pulls down the value of the domestic currency. The government keeps a close eye on domestic inflation and implements policies to keep it under a manageable range. But how do we measure inflation? That is where the Consumer Price Index, or CPI, comes into the picture.
What Is the Consumer Price Index (CPI)?
The CPI index is a metric to quantify inflation. It is calculated by tracking the change in the prices of essential products and services households consume over time. The consumer price index captures the inflation in a fixed set of items like transportation, food, medical care, education, etc., at the retail level.
The Consumer Price Index (CPI) measures the aggregate price level in an economy. The CPI consists of a bundle of commonly purchased goods and services.
The market basket used to compute the Consumer Price Index is representative of the consumption expenditure within the economy. It is the weighted average of the prices of goods and services. Why is it important? Because it affects the life of the people and their purchasing power in the economy. CPI is a widely used statistical measure to identify periods of inflation or deflation.
CPI serves the same purpose at the retail level as WPI (wholesale price index) does at the factory gate. Experts study both to understand how product price changes from the time it is manufactured and by the time it reaches the end customer.
Different countries use different basket of goods to calculate CPI and different base periods, like in India, CPI is calculated against 2012. The base period is the year zero from which the CPI calculation starts. It has given a value of 100. Goods prices are then calculated against the base period.
How is CPI calculated?
Just like the Wholesale Price Index, the CPI too is calculated concerning a base year. CPI can be easily calculated by dividing the cost of the basket of items in the current year by the price in the base year and multiplying the result by 100. The annual percentage change in CPI is used to assess inflation.
If you are a math geek, here is the formula to calculate CPI.
CPI= Cost of Market Basket in Given Year/ Cost of Market Basket in Base Year×100
Calculating CPI is a rigorous task.
In India, the agency estimates the price of 697 goods to determine CPI.
How Is CPI Measured In India?
India is a diverse country, and due to supply-side disparities, a product’s price may rise or decline in a rural area than in an urban area. For instance, let’s say there is a shortage of onions in the country. The concept of demand-supply dictates the price of onions will rise by certain percentage points.
The rise in price due to low production will be the same across the country. But some far-flung rural areas may see a higher increase in price due to the inefficiency of supply chains, which get aggravated when quantities decline.
The change in the price of the basket of goods and services is tracked at the rural, urban, and pan-India levels to get a balanced idea. Additionally, different products and services are assigned different weights in the basket. A product can also be important based on whether we measure rural or urban CPI. For example, food and beverages have 54.18 percent weight in rural CPI but carry only 36.29 percent weight at the urban level.
It is a highly dynamic metric, and it is quite a task to calculate the consumer price index. Different CPI is computed on different products’ clusters for convenience and better clarity over price movements.
Various series of the CPI are released. These are CPI for Industrial Workers (IW), CPI for Agricultural Laborer’s (AL), CPI for Rural Laborer’s (RL), CPI (Urban), and CPI (Rural). The Labor Bureau compiles CPI (IW), CPI (AL), and CPI (RL), while the CPI (Urban) and CPI (Rural), which have wider population coverage, are compiled by the CSO. These bodies are responsible for the compilation of data, but the collection of data requires extensive work. Field investigators fan to every corner of the country to collect data on price fluctuation from rural and urban areas.
The reason for calculating separate CPIs is to get clarity on the impact of inflation on different income sections. In a country like India with wide income disparity, it gives policymakers crucial insight to measure monetary policies’ effects on common people’s lives.
What is the importance of the CPI index?
Inflation can have a wide-ranging impact on people’s livelihood in a developing country like India. CPI is a measure of retail inflation, which gives a clear idea of the price rise for the common citizen.
It is a crucial metric to ascertain the cost of living in the country and provides vital pointers to policymakers. The Reserve Bank of India uses the CPI index as a major metric for formulating monetary policy. The Monetary Policy Committee has set itself a target of maintaining inflation within a 2 -6 percent band.
Conclusion
CPI gives a better glimpse of changes in the consumer’s purchasing power. Recently, The Central Statistical Office (CSO) changed the methodology of calculating CPI to make it more inclusive and robust. They have also changed the base year from 2010 to 2012 and incorporated changes in calculating the series from the average method to the geometric mean, which will align it better with international practices.
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