How does Consumer Price Index help?

How does Consumer Price Index help?

The Reserve Bank of India and other statistical agencies study CPI so as to understand the price change of various commodities and keep a tab on infl ation. CPI is also a helpful pointer in understanding the real value of wages, salaries and pensions, the purchasing power of a country’s currency; and regulating prices.

Economists are in charge of collecting data by surveying households on their buying patterns, most
purchased items, and daily expenses.
Changes in methodology of measuring inflation
Reserve Bank of India (RBI) had adopted the new Consumer Price Index (CPI) (combined) as the key measure of inflation. The national CPI is meant to measure retail inflation. This index will combine urban and rural CPIs, both under preparation and to be released simultaneously. Unlike many other countries, India does not have a unified CPI and uses the WPI as a benchmark. The unified CPI will usher in a fundamental shift in the way the Reserve Bank of India (RBI) targets inflation.
Effects of Inflation:
People’s desires are inconsistent. When they act as buyers they want prices of goods and services
to remain stable but as sellers they expect the prices of goods and services should go up. Such a happy outcome may arise for some individuals; “but, when this happens, others will be getting the
worst of both worlds.”
When price level goes up, there is both a gainer and a loser. To evaluate the conse quence of infl ation, one must identify the na ture of infl ation which may be anticipated and unanticipated. If inflation is anticipated, peo ple can adjust with the new situation and costs of infl ation to the society will be smaller.

One can study the effects of unanticipated infl ation under two broad headings:
Effects of Infl ation on Distribution of Income and Wealth:
During infl ation, usu ally people experience rise in incomes. But some people gain during infl ation at the ex pense of others. Some individuals gain be cause their money incomes rise more rapidly than the prices and some lose because prices rise more rapidly than their incomes during infl ation. Thus, it redistributes income and wealth.
Though no conclusive evidence can be cited, it can be asserted that following catego ries of people
are affected by infl ation differ ently:
–  Creditors and debtors:
Borrowers gain and lenders lose during infl ation because debts are fi xed in rupee terms.
When debts are repaid their real value declines by the price level increase and, hence, creditors lose. An individual may be interested in buying a house by taking loan of Rs. 7 lakh from an in stitution for 7 years.
The borrower now wel comes infl ation since he will have to pay less in real terms than when it was borrowed. Lender, in the process, loses since the rate of interest payable remains unaltered as per agree ment. Because of infl ation, the borrower is given ‘dear’ rupees, but pays back ‘cheap’ rupees. However, if in an infl ation-ridden economy creditors chronically loose, it is wise not to advance loans or to shut down business.
Never does it happen. Rather, the loan-giving institution makes adequate safeguard against the erosion of real value. Above all, banks do not pay any interest on current account but charges interest on loans.
–  Bond and debenture-holders:
In an economy, there are some people who live on interest income—they suffer most.
Bondhold ers earn fi xed interest income: These people suffer a reduction in real income when prices rise. In other words, the value of one’s sav ings decline if the interest rate falls short of infl ation rate. Similarly, benefi ciaries from life insurance programmes are also hit badly by infl ation since real value of savings deterio rate.
–  Investors:
People who put their money in shares during infl ation are expected to gain since the possibility of earning of business profi t brightens. Higher profi t induces own ers of firm to distribute profi t among inves tors or shareholders.

–  Salaried people and wage-earners:
Any one earning a fi xed income is damaged by in fl ation. Sometimes, unionized worker succeeds in raising wage rates of white-collar workers as compensation against price rise.
But wage rate changes with a long time lag. In other words, wage rate increases always lag behind price increases. Naturally, infl ation results in a reduction in real purchasing power of fi xed income-earners.
On the other hand, people earning fl exible incomes may gain during infl ation. The nominal incomes of such people outstrip the general price rise. As a re sult, real incomes of this income group in crease.
Profi t-earners, speculators and black marketers:
It is argued that profi t-earners gain from infl ation. Profi t tends to rise during infl ation.
Seeing infl ation, businessmen raise the prices of their products. This results in a bigger profit. Profit margin, however, may not be high when the rate of infl ation climbs to a high level.
However, speculators dealing in business in essential commodities usually stand to gain by inflation. Black marketers are also ben efi ted by infl ation.
–  Effect on Production and Economic Growth:
Infl ation may or may not result in higher output. Below the full employment stage, inflation has a favourable effect on production.
In general, profi t is a rising function of the price level.
An infl ationary situation gives an incentive to businessmen to raise prices of their products so as to earn higher volume of profit.
Rising price and rising profi t encourage fi rms to make larger investments.

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