Food and Beverages, fuel, health, education, haircut, transport, etc.; almost all types of expenditures of a common citizen on purchasing goods and services are taken into account while calculating Consumer Price Index (CPI). The percentage of change in CPI for a given year can be regarded as the Inflation rate of that year. CPI is also used for indexing dearness allowance to employees for increase in prices. CPI is therefore considered as one of the most important economic indicators.
Consumer Prices also gives the better idea about real wages, lifestyle, purchasing power of the Rupee, salaries etc. Before APRIL 2014, India used to follow WPI index over CPI to calculate the Inflation. If you want to learn the difference between two, you can follow the link of article provided below or in later section of this article, we are also going to discuss it.
Definition of Consumer Price Index (CPI):Writing definition of Consumer Price Index (CPI) is just a formality here. We have talked about this above also. But for the sake of ranking this article higher in google search results, I must write it. I would like to write the definition in very easy language so that everyone would be able to understand.
Consumer Price Index (CPI) is a chart of data collected to represent the overall change in prices of retail product basket over a given period of time which government and the central Bank (RBI in the case of India) uses to get an idea of Inflation and make decisions regarding Fiscal Policy, Monetary Policy, Repo and Reverse Repo rates accordingly.
What is Basket of goods?It is an imaginary Basket containing all the products and services used by the consumers. When we say Basket of Products, it means that we are talking about all the products taken into account while calculating the Consumer Price Index (CPI). As the value of products inside this basket changes, overall value of the Basket also changes. Change in the price of Basket is the weighted average of change in individual price of the category of product. As it is a matter of average, we should be having idea about What is the weightage given to each category of products:
- Food and Beverages – 45.86%
- Pan, tobacco and Intoxicants - 2.38%
- Fuel and light – 6.84%
- Housing – 10.07%
- Clothing and Footwear – 6.53%
- Miscellaneous (it includes services like transportation, education etc.) – 28.32%
Formula of Consumer Price Index (CPI):Formula of Consumer Price Index (CPI) is as follows:
What is a Base year?In India, we use 2012 as the Base year for CPI. The value of CPI for base year is taken to be as 100. It is not like that all products of basket could be bought for Rs.100 in 2012, but their value was made equivalent to Rs. 100 or we can say that 100 represent the 100% value of basket in 2012.
For example (only imaginary), total value of the Basket in 2012 was Rs. 1crore and this value is made equal to 100 in CPI chart by dividing it with 1 lakh. Now, the value of Basket changes from Rs 1 crore to Rs1.1 crore. To write its CPI equivalent, we will divide it with 1 lakh and the CPI value comes out to be 110. It means that the Consumer Price Index (CPI) value have increased by 10% in 1 year. So, the inflation for that year would be considered equal to 10%.
Consumer Price Index in India:
Types of CPI:Each country has their different set of CPIs’ depending on the different types of people in their country. Each country has a different set of people for ex. India is have very large population dependent on Agriculture and if we talk about Singapore, it is completely opposite. In India, we have 4 types of CPI’s calculated:
• CPI (Rural/Urban/Combined):CPI(UNME) is recorded, calculated and managed by the Ministry of Statistics and Programs implementation (MOSPI)
• CPI for Industrial Workers (IW):
• CPI for Agricultural Laborer (AL):
• CPI for Rural Laborer (RL):while other three are managed by the Labour Bureau in the Ministry of Labour.
WPI VS CPI:WPI – Wholesale Price Index
CPI – Consumer Price Index
WPI and CPI both are price Indexes keeping track of change in prices of the product basket over a given period of time. Wholesale Price Index is composed by calculating the change of price in the wholesale market while Consumer Price Index measures the change in prices paid directly by the consumer in Retail Market. Moreover, WPI data counts only the changes in the prices of material products and energy but CPI counts the changes in price services like transportation and education as well.
So, it is obvious that if we want to calculate the inflation in life of a common citizen, CPI would be best choice while WPI gives the better understanding about changes at manufacturing and wholesale level. This is the main reason why RBI started using the CPI based inflation over WPI based Inflation for planning Monetary Policies