Inflation
Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.
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When the price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money
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Generally accepted 2 Causes of Inflation
Demand-Pull Inflation -“too much money chasing too few goods”. In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies.
Cost-Push Inflation – When companies’costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports.
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Negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future.
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Positive efects of inflation it gives an incentive to spend and invest, reduces the real burden of debt, both public and private,keeps nominal interest rates above zero, reduces unemployment to the extent.
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Measuring Inflation
Inflation rates in India are usually quoted as changes in the Wholesale Price Index, for all commodities. Many developing countries use changes in the Consumer Price Index (CPI) as their central measure of inflation.
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Wholesale Price Index is the primary index used by India to calculate inflation (read headline inflation). The WPI consists of a basket of 676 commodities (revised from 435 with base year 1993-94) and their price changes are used to calculate the value of the index. The base value of the index is taken to be 100 with base year 2004-05. The revised WPI numbers have been adopted in September 2010. The percentage change in the value of the index over a specified period reflects the inflation rate.It measures the price of a representative basket of wholesale goods.
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The overall CPI is meant to measure the cost of a representative basket of goods and services consumed by an average household. CPI numbers are widely used as a macro-economic indicator of inflation, as a tool by governments and central bank for inflation targeting and for monitoring price stability, and as deflators in the national account. The CPI numbers currently presented at the national level pertain to only specific segments of population viz. Industrial workers, agricultural laborers and rural laborers. Hence the CPI numbers do not reflect a true picture of the price behavior of the country.
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A key difference between CPI and WPI is the weightage each index gives to different segments. For instance, the new WPI gives 65% weight to manufactured goods. The food and food products account for only 24.3% of WPI. In contrast CPI has 46.2% weight in food and food products, while manufactured products account for a much lower weight. This makes CPI indices more susceptible to volatility in the food prices.
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The annualized inflation rate in India is 3.78% as of August 2015.
