CPI is the measuring index of the changes in the price level of consumer goods and services bought out by households. The Consumer Price Index is the estimated calculation in numerical values using the rates of the representative sample objects gathered periodically.
The Consumer Price Index notes the changes in the prices at the consumer level. In contrast, the Wholesale Price Index (WPI) calculates price changes at the producer level. The WPI cannot note the price change in the service provided, but the CPI can capture this change.
Types of CPI
Consumer Price Index (CPI) in India is calculated in four different ways to measure the price changes and cost of living for various segments of the population. These types of CPI provide valuable insights into inflationary trends and help in formulating policies to address the specific needs of different groups. These different types of CPI data are collected and compiled by the Ministry of Statistics and Program Implementation, along with the Labor Bureau under the Ministry of Labour. The types of CPI in India include:
- CPI for Industrial Workers (CPI-IW): Measures price changes for goods and services consumed by workers in industries.
- CPI for Urban Non-Manual Employees (CPI-UNME): Focuses on price variations for urban non-manual employees and is compiled by the National Statistical Office.
- CPI for Agricultural Labourers (CPI-AL): Assesses price fluctuations for agricultural laborers and is used to calculate minimum wages in the agricultural sector across different states.
- CPI for Rural Labourers (CPI-RL): Compiled by the Labor Bureau, it reflects price movements specifically for rural laborers.
Working Process of Consumer Price Index in India
Consumer Price Index in India measures price changes by comparing the cost of a fixed set of commodities over time. The set is based on the expenses of a target population over a reference period. Since the set contains commodities of constant or identical quality and quantity, the index reflects only the pure price.
The price data of goods and services are collected periodically, and the inflation levels in the economy are calculated by using the data collected from the CPI. This is further used to compute the cost of living. Not only this, but the Consumer Price Index also provides insights into how much a consumer can spend to be on par with the price change in an Indian Economy.
Advantages of the Consumer Price Index
Over the years, CPI has been commonly used as a macroeconomic indicator of inflation and a tool by the Central Bank and the Government to monitor price stability and target inflation. Hence, the Consumer Price Index is considered one of the key economic indicators. The Reserve Bank of India and other agencies study CPI to interpret the price change of various commodities and keep a check on inflation. The advantages of the Consumer Price Index include:
- Accuracy: The CPI captures price changes for a wide range of goods and services, providing a comprehensive picture of inflationary trends.
- Comparability: The CPI allows for comparisons across different time periods, regions, and demographic groups, enabling meaningful analysis of price movements.
- Policy formulation: The CPI serves as a vital tool for policymakers in formulating economic policies, including adjustments to wages, social benefits, and taxation.
- Cost-of-living adjustments: The CPI is often used to calculate cost-of-living adjustments, ensuring that wages, pensions, and benefits keep pace with inflation.
- Economic indicators: The CPI is used as a key economic indicator to assess the overall health of the economy and monitor inflationary pressures.
Calculation of Consumer Price Index
CPI is calculated regarding a base year, which is used as a benchmark. The price Reference Year (Base Year) has been selected as the calendar year 2012. The price change pertains to that year. When the Consumer Price Index is calculated, the price of the set in 1 year is divided by the price of the market set of the base year; then, it is multiplied by 100. The process of calculating the CPI includes:
Selection of the CPI basket:
A representative basket of goods and services is selected to reflect the average consumption patterns of households. This basket includes items such as food, housing, transportation, healthcare, education, and more.
Collection of price data:
Prices of the selected items in the CPI basket are collected regularly from various sources, such as retail outlets, service providers, and government agencies. Data collection is typically done through surveys, online sources, and direct observations.
The weighting of items:
Each item in the CPI basket is assigned a weight based on its relative importance in the average consumer’s expenditure. The weights reflect the proportion of income spent on different categories of goods and services.
Price index calculation:
The price index for each item is calculated by comparing its current price to the price in a base period. This is done using specific formulae, such as the Laspeyres or Paasche formula, to account for changes in quantity and quality.
Aggregation of price indices:
The price indices for individual items are aggregated using the respective weights assigned to them. This aggregation results in a single overall CPI number, which represents the average price change for the entire basket of goods and services.
Calculation of inflation rate:
The inflation rate is determined by comparing the current CPI with the CPI of a previous period. The percentage change in the CPI over time indicates the rate of inflation or deflation in the economy.
The annual percentage change of CPI is also used to evaluate inflation. In India, the base years of the current series of CPI(RL), CPI(IW), and CPI(AL) are 1984-85, 1982, and 1986-87, respectively.
CPI = (Cost of the market basket in the year/Price of the market basket in the base year) x 100
CPI is calculated for a fixed set of items, including food, apparel, housing, electronics, transportation, medical care, education, etc. India’s Consumer Price Index increased from 175.70 points in December 2022 to 176.50 points in January 2023.
Significance of CPI
Consumer Price Index (CPI) holds significant importance in various aspects of the Indian economy. It is widely used as a measure of inflation and plays a crucial role in monetary policy and economic planning The following are the significance of CPI:
- Measure of inflation: CPI serves as a key indicator of price changes in a basket of goods and services consumed by households. It helps in assessing the overall rate of inflation and monitoring changes in the cost of living.
- Monetary policy tool: The Reserve Bank of India (RBI) uses CPI as a nominal anchor for conducting monetary policy. The Monetary Policy Committee aims to keep CPI within a target range of 2% to 6%. This ensures price stability and guides the RBI in making decisions on interest rates and other policy measures.
- Deflator in National Accounts: CPI is employed as a deflator in the National Accounts, which adjusts the nominal values of goods and services to reflect changes in price levels. This helps in accurately estimating real economic growth and analyzing various economic indicators.
- Calculation of Dearness Allowance: CPI is used to calculate the Dearness Allowance (DA) for government employees and pensioners. DA is adjusted based on changes in CPI to offset the impact of inflation on their salaries and pensions.
Why was CPI Chosen Instead of WPI?
The Consumer Price Index (CPI) was chosen as an inflation indicator in India instead of the Wholesale Price Index (WPI) for several reasons. The decision to shift to CPI was made in 2014 due to the following factors:
- Reflecting consumer prices: CPI measures the inflation rate at the consumer level, taking into account the prices of goods and services that consumers typically purchase. This makes it a more accurate indicator of inflation experienced by households compared to WPI, which primarily focuses on wholesale prices.
- Inclusion of essential services: CPI is chosen instead of WPI because it includes essential services like medical care and education, which have a significant impact on people’s lives and overall inflation. This broader coverage provides a more comprehensive understanding of inflation trends.
- Better representation: CPI is preferred over wholesale prices as it reflects actual costs for consumers and considers their spending patterns. This accuracy makes CPI a valuable tool for policy-making and decision-making regarding inflation.
The Consumer Price Index is a crucial topic in the Indian Economy section of the UPSC Syllabus. To get in-depth knowledge about this concept, candidates should refer to the Indian Economy Books.
Check the information about the types, significance and advantages of the CPI provided above in detail for better understanding. Candidates can even get help from UPSC PYQs to get references for the questions asked on the topic of CPI.
Consumer Price Index UPSC Questions
Question: What does the consumer price index (CPI) calculate?
- (A) Price of services only
- (B) Price of goods only
- (C) Price of both goods and services
- (D) None of the above
Answer: (C) Price of both goods and services
Question: Who issues the data of the consumer price index (CPI)?
- (A) Ministry of Commerce and Industry
- (B) Ministry of Finance
- (C) Ministry of Statistics and Program Implementation
- (D) None of the above
Answer: (C) Ministry of Statistics and Program Implementation
Question: What is the base year of the consumer price index (CPI)?
- (A) 2001
- (B) 2012
- (C) 2004
- (D) 2015
Answer: (B) 2012