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How Inflation Is Measured

December 7th, 2009

How Inflation Is Measured To measure inflation, a number of goods that are representative of the economy are put together into market basket. It is then compared over time. This results in a price index. Price index shows the changes in the cost of the present market basket as a percentage of the cost of that identical basket in the previous year.

There are two main price indexes that measure inflation:

  • Consumer Price Index (CPI) – A measure of price changes in the retail market of consumer goods and services such as petrol, food, clothing and automobiles. The CPI measures price change from the perspective of the retail buyer. It is the real index for the common people. It reflects the actual inflation that is borne by the individual. This is not taken into consideration in India.
  • Wholesale Price Index (WPI): It is used in India. It takes into account the rise in prices of goods and services in a select range of goods and services at the wholesale level. Since the general public does not buy at the wholesale level, it does not give the actual feeling of the amount of pressure borne by the general buyer. But the increase in wholesale prices does affect the retail prices and as such give a feeling of the consumer prices.
  • Producer Price Indexes (PPI) – A group of indices that measure the average change over time in selling prices by producers of goods and services. They measure price change from the point of view of the seller.
  • Cost-of-living indices (COLI): These show the fixed incomes and contractual incomes based on measures of goods and services price changes.

In the long run, the various PPIs, WPIs and the CPI show a similar rate of inflation. In the short run PPIs often increase before the WPI and CPI. Investors generally follow the CPI more than the PPIs. In India WPI is used instead of CPI.

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