Wednesday, February 11, 2015

Inflation - Part II (Price Indices - PPI, WPI, CPI)

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Measurement of Inflation
Price indices are used to measure the relative price changes (of goods and services) in a region (generally a country) during a specific period of time (e.g., financial year, or quarter, or month).

With the price indices, we comprehend about how much the price of goods and services has increased (Inflation) or decreased (Deflation) from a fixed normal year, known as base year (with respect to this base year, we calculate how much increase or decrease in prices happened in this current year).

Price indices are generally used to measure the cost of living in order to determine the wage increases necessary to maintain a constant standard of living.

Price Indices
Goods and services are provided to the consumer by the producer. It follows several stages / levels in between -
  • producer level (produced, or manufactured) - PPI
  • wholesale level (at wholesale market, before going to the retail market) - WPI
  • retail / consumer level (at retail market, from where consumers buy) - CPI

Wholesale Price Index (WPI)
WPI is used to track prices of goods at the wholesale stage (meaning goods sold in bulk, rather that retailed), and traded between organizations, before going to consumers.

It is practically impossible to find price changes of all the goods traded in an economy (millions of goods!). So it is logical to take a sample set, or 'basket of goods' (e.g., 676 commodities, or goods) to measure the inflation (few important goods taken for measuring price changes).

Then determine a base year (e.g., 2004-05, 2010-11), with respect to which the current inflation will be measured. WPI indicator tracks the price movement of each commodity individually, and then determine through the averaging principle (Methods like Laspeyres formula, Ten-day Price Index, etc. are used)

Note that all commodities are classified into 3 groups, and then their weighted average is taken for measuring WPI -

  • Primary Articles (e.g., food, non-food, mineral, etc.) - 20.1 % of total weight
  • Fuel & Power (Coal, Mineral Oil, Electricity, etc.) - 14.9 % of total weight
  • Manufactured Articles (food products, beverages, woods, paper, chemicals, machinery, transport, etc.) - 65 % of total weight

Indian wholesale prices increased by 0.11 % in December 2014 after being flat (0 %) in November 2014. 


Consumer Price Index (CPI)
While WPI is calculated in wholesale stage, CPI is determined at retail stage, where consumers are directly involved. Hence, CPI method better measures the effect of inflation on general public. RBI adopted CPI as the key measure for determining Inflation situation of economy, on recommendation of Urjit Patel committee.

CPI measures changes in prices, paid by consumers for a basket of goods (similar to WPI, but here retail goods, instead of wholesale goods).

There are 3 broad types of CPIs - (for different type of consumers; new CPI system of 2012)

  • CPI for Urban population, known as CPI (Urban)
  • CPI for Rural population, known as CPI (Rural)
  • Consolidated CPI for Urban and Rural, which is based on CPI (Urban) and CPI (Rural) - key measure for CPI
CPI in India decreased to 144.90 Index Points in December 2014 from 145.50 in November.


Producer Price Index (PPI)
PPI is used to track pure price changes at producer level for goods as well as servicesPPI prices of many products and some services are determined form first commercial transaction.
Note that in contrast to WPIPPI doesn't contain tax components, keeping inflation free of tax fluctuations.

The government of India has set up (Sep, 2014) a committee (13 members), headed by Professor B.N.Goldar, to devise PPI for Indian economy. It is an international standard, which is followed by major economies (e.g., USA) of the world.

Why devising PPI in India?
  • Currently, there is no index tracking inflation in service sector, that contributes about 55 % to India's GDP (note that WPI doesn't track services sector in India)
  • PPI tracks inflation excluding tax components. It will help to track actual change in prices (note that WPI, CPI, both includes tax components)


Disclaimer - This article only gives a basic idea, just for learning purpose. No figure or content mentioned here to be considered as accurate.


(to be continued..)


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