The inflation means a situation where the prices of commodities are continuously increasing in an economy over a period of time. The policies to avoid high inflation, unemployment and to encourage economic growth are the major issues of contemporary time. In a good economic set up the government takes positive steps to control the upswings movement of the inflation rates by imposing anti- inflation policies. In this article we are going to discuss about the meaning, types of inflation and methods of calculating inflation.


What is Inflation?

In broad sense, inflation refers to considerable as well as continuous rise in general price level over a period of time. However there is no universally accepted definition for this term in fact it is a matter of opinion of different persons. Some of the early quoted definitions of inflation are as follows:

According to Pigou, “Inflation exists when income is expanding more than in proportion to the increase in income earning activities.”
Coulbourn suggested inflation as “a situation in which too much money chases too few goods.”

In general the early definitions considered inflation as a situation in which supply of money increases at a much faster rate than increase in supply of output. But such situations were unable to capture the true meaning of the full implications of inflationary pressure.
Let us discuss some recent definitions of the term Inflation.

According to Ackley, “inflation is a persistent and appreciable rise in general level or average of prices.”
Samuelson defined inflation as “rise in general level of prices.”
According to Harry G. Johnson, “inflation is a sustained rise in prices.”

In the light of above discussed definition a general definition can be given as:
Inflation refers to a situation when there is continuous and appreciable rise in the general price level of the commodities owing to either increase in supply of money as compared to production capacity in the economy or due increase in cost of production.
 

Types of Inflation

Generally inflation is categorized either on the basis of causes or rate. Let us discuss both the ways of classification separately.

A) Classification on basis of Causes

a) Demand pull inflation – Such inflation occurs in a situation when rate of increase in aggregate demand is much more rapid than increase in aggregate supply i.e. AD > AS. The major reasons for such inflation are :
   i) Monetary factors, i.e., increase in supply of money
  ii)  Real factors, i.e., increase in demand for real output


b) Cost push inflation – Demand is not the only factor which creates inflation. The recession in western countries in year 1958 is a famous instance when aggregate  demand declined but still the prices were increasing. This situation led to the birth of cost push theory of inflation. It states that if cost of factors of production is  increasing then it will also  lead to increase in price of product. This can further be classified into following categories :
i) Wage push inflation
ii) Profit push inflation
iii) Supply shock inflation


B) Classification on basis of rate

a) Moderate inflation – Moderate or creeping inflation refers to rise in general price level at a moderate rate over a long period of time.  This rate may vary from country to country. Inflation at moderate rate is considered as socially desirable for the growth of a country.

b) Galloping Inflation – In words of Samuelson and Nordhaus , “ Inflation in double or triple digit range of 20,100 and 200 percent in a year is labelled as galloping inflation.” This type of inflation is also known as jumping inflation. It effects badly middle and low income groups of society.

c) Hyper inflation –Hyper inflation refers to the situation when price rise is beyond three digit rate per annum. During the period of hyperinflation value of paper currency becomes worthless and demand for money decreases drastically.

    Methods for calculation

In India, there are mainly two indexes used for calculating inflation, these are Wholesale Price Index (WPI) and Consumer Price Index (CPI).

1. Wholesale Price Index (WPI) 

Wholesale Price Index (WPI) is an indicator which shows changes in prices in wholesale market. It is a method wherein the prices are quoted at wholesale prices and are published on weekly basis by the Office of Economic advisor, Ministry of Commerce and Industry. It was published for the first time in 1942 and after independence in1947 till 2011, this measure was used for calculating the inflation rate in India. This method helps to measure general rate of inflation and WPI for base year is assumed as 100. The formula for calculating WPI is as follows:

WPI =    Price in current year (-) Price in base year     x 100
                              Price in base year

Let us calculate the WPI for year 2017 for a particular commodity i.e. Rice. Suppose the price of 1kg of rice in 2012 was Rs.30 and in 2017 the price of 1 kg rice was Rs.40. We will calculate the WPI for year 2017 wherein we assume 2012 to be base year.
 
WPI = 40- 30  x 100
              30
        = 10   x  100  
           30
        = 33.33

WPI for base year 2012 is 100 so WPI for 2017 is 133.33

2. Consumer Price Index (CPI) 

CPI is a measure which helps to examine the weighted average price of basket of commodities. It helps to measure cost of living. As opposed to one WPI there are four types of CPI’s in India i.e.
a) CPI combined 
b)  CPI for agricultural labourers
c)  CPI for rural labourers
d)  CPI for industrial workers

Formula for calculating CPI is as follows:
CPI = P1 x 100
             P0
here, P1 = Price of market basket in current year
         P0 = Price of market basket in base year
 
E.g. With the help of following information calculate consumer price index for year 2018 taking 2012 as base year.

Commodities

Price in 2012

Price in 2018

Food

Clothing

Other

50

30

45

55

40

40

Total

125

135

 
CPI = Price in year 2018   x 100
          Price in year 2012
        =  135    x 100
            125
       =   108
Inflation rate = CPI in current year – CPI in base year
                     =  108 – 100
                     =  8 percent
 
Table2: Various price indexes prepared in India

Index

Issued by agency

Base year

Wholesale Price Index

Office of Economic advisor, Ministry of Commerce

2011-12

CPI combined

Central Statistical Organisation, Ministry of Statistics   and Programme Implementation

2012

CPI for agricultural labourers

Labour Bureau , Ministry of Labour and employment

1986-87

CPI for rural labourers

1986-87

CPI for industrial workers

2001


Table 2 gives information about various price indices used in India. It gives information about regulatory bodies who frame them as well it tells about base years taken in various indices.

Conclusion

Inflation is a pervasive economic process which by some degree effects every citizen and every corner of the economy. In this article we have discussed about the meaning and types of inflation and what are the various measures to calculate inflation in India. For notes on more such topics subscribe to our blog.