Inflation in India

Understanding Inflation

Back to Basics: In 1947, when India got independence, the Indian economy was suffering from low growth, poverty and resource shortages. The salary of an average Indian was very low. Ask your Grand Parents ‘how much they use to earn in the 1950’s?

Today, an average Indian earns 100 times more than what his grandparents use to earn. Does it mean that the standard of living of the people has also risen 100 times? Before reaching to such a conclusion, one must remember that the prices of goods and services in the economy has also risen.

In 1950’s a Delhi-Mumbai air ticket cost in some hundreds, today it cost in thousand. Similarly, the price of Wheat was in few Paisa; it cost around Rupee 50/kg. Therefore, it is not clear from income, that whether the standard of living of people have risen or not.

To compare the salary of your grandparents to yours, we need some measure of purchasing power or price. The meaningful measure that can perform the task is “Consumer Price Index”.

Consumer Price Index: CPI is used to monitor changes in the cost of living over time. When the CPI rises, the average Indian family has to spend more on goods and services to maintain the same standard of living. The economic term used to define such a rising prices of goods and services is Inflation.

Inflation: Inflation is when the overall general price level in the economy is increasing.

Inflation Rate: Inflation Rate is the percentage change in the price level from the previous period. If a normal basket of goods was priced at Rupee 100 last year and the same basket of goods now cost Rupee 120, then the rate of inflation this year is 20%.

Inflation Rate= {(Price in year 2 – Price in year 1)/ Price in year 1} *100

Whole sale Price Index: WPI is used to monitor the cost of goods and services bought by producer and firms rather than final consumers.

GDP Deflator: Another important measure of calculating standard of living of people is GDP Deflator. GDP Deflator is the ratio of nominal GDP to real GDP. The nominal GDP is measured at the current prices whereas the real GDP is measured at the base year prices. Therefore, GDP Deflator reflects the current level of prices relative to prices in a base year. Example, In India the base year of calculating deflator is 2011-12.

The Difference

Consumer Price Index	GDP Deflator
CPI reflects the price of goods and services bought by the final consumers.	GDP deflator reflects the price of all the goods and services produced domestically.
Example: Suppose the price of a satellite to be launch by ISRO increases. Even though the satellite is part of the GDP of India, but it is not a part of normal CPI index, since we don’t consume satellite.	The price rise of the ISRO satellite will be reflected in GDP deflator.
Similarly, India produces some crude oil, but most of the oil/petroleum is imported from the West Asia, as a result, when the price of oil/petroleum product changes, it is reflected in CPI basket as petroleum products constitute a larger share in CPI.	The price change of oil products is not reflected much in the GDP deflator since we do not produce much crude oil.
The CPI compares the price of a fixed basket of goods and services to the price of the basket in the base year.	The GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year. Thus, the group of goods and services used to compute the GDP deflator changes automatically over time.

 

 

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University