My grandfather usually tells my father that

my salary in 1950s was Rs.5, but still I was

able to manage the household better than
you, inspite of your salary being 1 lakh a
month
What has happened over the years? Is it that our life style has become
so much better? Are we eating snacks and food made of gold?
The point is…
Over the years we are facing a phenomena of constant increase
in price level. This is known as inflation.

Inflation is calculated using an index known as CPI. In the

previous chapter we saw one more method of calculating
inflation. What was that?

But the inflation calculation we see in the economy is based on

CPI not GDP Deflator.
What is CPI?
• Consumer Price index is a measure of the overall cost of goods and
services bought by a typical consumer.
• In India MOSPI calculates inflation (Ministry of Statistics and Program
Implementation) every month.
• There are two indexes that indicate inflation in India namely WPI and
CPI.
Lets see how CPI is calculated?
• Lets take an example. Suppose Hardik Desai , goes to DMART every
month and buys a fixed category of products.
• How can he measure whether there is
inflation in the economy or not?
Lets see how CPI is calculated?
• Fix the Basket: The MOSPI fixes a basket of goods that are most
important to the Indian consumers. The weightage is decided by
surveying the consumers.
http://mospi.nic.in/sites/default/files/CPI/State_wise_indices_jan_20
21.pdf
• http://mospi.nic.in/cpi
• How are weights of different products in the basket calculated?
https://www.livemint.com/news/india/cpi-weights-need-rejig-for-gaugi
ng-inflation-better-11582218025628.html
Lets see how CPI is calculated?
• Find the prices of the goods in the basket.
Price Collectors as well as Supervisors who are generally the employees
of the State Governments and normally belong to the
Directorate/Bureau of Economics and Statistics or Labour Department
Personal visits retail prices of various commodities and services
included in the relevant index, on fixed days every week (or month in
respect of some commodities) from selected shops in the markets
assigned to them
Lets see how CPI is calculated?
• Compute the baskets cost: After finding out the price of the individual
items in the basket, the cost of the entire basket is calculated.
• Choose a base year and calculated the CPI:
• For CPI Calculation in India the base year is 2012.
• CPI = Price of basket of goods and services in Current Year
---------------------------------------------------------------------- x 100
Price of basket of goods in the base year
Lets see how CPI is calculated?
• Compute the Inflation Rate:

Inflation Rate: CPI in year 2- CPI in year 1

----------------------------------- x 100
CPI in year 1
 CALCULATE CPI AND INFLATION RATE FOR 2019, 2020 AND 2021 –
(2019 AS BASE YEAR)

Find the cost of the basket:

2019- (4x1) + (2x2) = 8
2020- (4 x 2) + (2x3) = 14 Inflation Rate:
2021- (4 x 3) + (2x4) = 20
2020: 175-100/100 * 100 = 75%
CPI 2021: 250-175/175 * 100 = 43%
2019- 8/8 X 100 = 100
2020- 14/8 X 100 = 175
2021- 20/8 X 100 = 250
Lets listen about Inflation from Financial
Express.
• https://www.financialexpress.com/what-is/inflation-meaning/161898
1/
How do we measure inflation rate in the
economy?
• Using Consumer Price Index.
• What is CPI: It is measure of the overall cost of goods and services
bought by a typical consumer.
• CPI helps us in gauging the general price level in the economy. If the CPI
increases, its an indication that the general price level in the economy
is increasing.
• What are the steps for calculating CPI?
• A basket of goods is fixed by the MOSPI, Price of the goods is collected
by various price collectors across selected markets, Cost of the basket is
estimated, CPI is calculated, Inflation Rate is calculated.
Three problems in measuring cost of Living using CPI.
Does CPI give an actual indication of cost of Living?
• Substitution Bias: Because the basket is fixed, the consumers substitution of
goods is not considered while calculating CPI. Hardik Desai removed Hide
and Seek and bought tiger while shopping, but because the basket is fixed,
CPI is inflated.
• Introduction of New goods is not considered in the CPI calculation as the
basket is fixed.
• Unmeasured Quality Change: If you bought Splendor in 2000 and you are
buying it today for Rs.50,000. Are you getting the same value?
• The problem that happens if these things are not considered is that most of
the social welfare schemes/pension are tied to CPI. This may lead to
underestimation of cost of living.
GDP Deflator V/S CPI
• GDP deflator considers products and services produced within the
domestic frontiers of a country while CPI considers the goods in the
consumers basket.
• For eg: GDP Deflator considers a car produced by TATA, but it might
not be considered in CPI as its not a part of the basket of CPI
calculation. Similarly, Apple Iphone might be Twix, Mars, Bounty
might be considered in the basket of consumers hence will be a part
of CPI calcuation, but because they are imported chocolates, they
might not be considered in GDP deflator. Right now fuel prices are
spiking, this you will see in CPI, but not in GDP deflator.
GDP Deflator V/S CPI
• GDP Deflator takes into consideration the prices of goods and services
currently produced whereas in the case of CPI, basket is fixed, and
doesn’t change frequently. (In this case GDP deflator considers
introduction of new goods, whereas CPI does not).
Comparing Rupee Figures from Different
times.
• If you want to find out if Hardik’s salary of 15,000 rupees in 2013 was
high or low than Akshay getting 22,000 today.

Amount today = Amount in year T X Price level today (CPI)

Price level (CPI) in T year

= 15,000 X 156/80
= 15,000 X 1.95 = 29,250
Indexation
• When some rupee amount is automatically corrected for changes in
the price level by law or contract, the amount is said to be indexed for
inflation.
• For example, some long-term contracts between firms and unions
include partial or complete indexation of the wage to the CPI. Such a
provision, called a cost-of-living allowance (or COLA), automatically
raises the wage when the CPI rises. (TA/DA)
• Pension etc.
Nominal and Real Interest Rate
• Suppose Parth Deposits Rs,50,000 in a bank FD for 3 years and gets
an interest of 10% per year on his FD and gets 70,000 after 3 years. Is
he richer and better off with Rs.20,000 interest.
Suppose Deval deposits 3,00,000 in a bank that gives him 10%
interest rate per annum, after 1 year he uses the amount to buy
mobile phones worth Rs.30,000 for his family members. How
many phones can he buy? What is the value of his investment
today?
• If there is zero percent inflation: He has 3,30,000 and the price of one phone
is 30,000, so he can buy 11 phones.
• If there is 6 percent inflation: He has 3,30,000 and the price of one phone now
is 31,800. he can buy 10 phones.
• If there is 12% inflation: He has 3,30,000 and the price of one phone now is
33,600. he can buy 9 phones.
• Ten percent deflation: He has 3,30,000 and the price of one phone now is
27,000. he can buy 12 phones.
Nominal and Real Interest Rate
• Nominal Interest rate is the rate of interest you get on your
investments without considering inflation.
• Real Interest rate is nominal interest rate-inflation rate.

• Real interest rate= Nominal Interest rate-inflation rate

Which rate gives you an actual idea of your purchasing power?

Whats happening with Petrol Prices?
https://www.youtube.com/watch?v=ASJLyv_SZ6Q