Inflation: Concept, Types and Measurement | RBI Grade B Phase 2 Preparation - Bank Exams PDF Download

 Page 1


 
UNIT 7 INFLATION: CONCEPT, TYPES  
 AND MEASUREMENT
?
 
 
Structure 
7.0  Objectives 
7.1  Introduction 
7.2 Measurement of Price Level  
 7.2.1  Definition of Index Number 
 7.2.2  Types of Index Numbers 
7.3  Inflation Defined 
7.4  Types of Inflation 
 7.4.1  Moderate Inflation 
7.4.2  Galloping Inflation 
7.4.3  Hyper-Inflation 
7.4.4  Stagflation 
7.4.5  Deflation 
7.4.6  Core Inflation 
7.5 Let Us Sum Up 
7.6  Answers/ Hints to Check Your Progress Exercises 
 
7.0  OBJECTIVES 
 
After going through this unit you should be in a position to 
? explain the concept of inflation; 
? explain how inflation is measured;  
? distinguish between various types of price indices to measure inflation; and 
? identify the types of inflation; 
 
7.1  INTRODUCTION 
We come across the term inflation very often in newspapers. The reason why it 
holds such importance is because of its adverse effects on an economy as well as 
people. A question that could arise at this point is in what way does inflation 
affect our everyday life? Let us illustrate with the help of a single household. 
Inflation, in simple words, is a steady rise in the prices of various goods and 
services. Given the level of the money income, a household consumes a group 
of commodities at a given price level. With inflation, the price level goes up. So 
with the same level of money income, the household could consume a smaller 
amount of the commodities than it was consuming earlier. Alternately, to maintain 
the earlier level of consumption this household now needs to have more money. 
                                                           
?
 Dr. Gurleen Kaur, Assistant Professor, Sri Guru Govind Singh College of Commerce, University of   
 Delhi. 
Page 2


 
UNIT 7 INFLATION: CONCEPT, TYPES  
 AND MEASUREMENT
?
 
 
Structure 
7.0  Objectives 
7.1  Introduction 
7.2 Measurement of Price Level  
 7.2.1  Definition of Index Number 
 7.2.2  Types of Index Numbers 
7.3  Inflation Defined 
7.4  Types of Inflation 
 7.4.1  Moderate Inflation 
7.4.2  Galloping Inflation 
7.4.3  Hyper-Inflation 
7.4.4  Stagflation 
7.4.5  Deflation 
7.4.6  Core Inflation 
7.5 Let Us Sum Up 
7.6  Answers/ Hints to Check Your Progress Exercises 
 
7.0  OBJECTIVES 
 
After going through this unit you should be in a position to 
? explain the concept of inflation; 
? explain how inflation is measured;  
? distinguish between various types of price indices to measure inflation; and 
? identify the types of inflation; 
 
7.1  INTRODUCTION 
We come across the term inflation very often in newspapers. The reason why it 
holds such importance is because of its adverse effects on an economy as well as 
people. A question that could arise at this point is in what way does inflation 
affect our everyday life? Let us illustrate with the help of a single household. 
Inflation, in simple words, is a steady rise in the prices of various goods and 
services. Given the level of the money income, a household consumes a group 
of commodities at a given price level. With inflation, the price level goes up. So 
with the same level of money income, the household could consume a smaller 
amount of the commodities than it was consuming earlier. Alternately, to maintain 
the earlier level of consumption this household now needs to have more money. 
                                                           
?
 Dr. Gurleen Kaur, Assistant Professor, Sri Guru Govind Singh College of Commerce, University of   
 Delhi. 
 
74 
 
Inflation and 
Unemployment 
For example, suppose the household has a monthly income of Rs.100, consumes 
the entire income on a single commodity A and does not save anything. If the 
price of commodity A is assumed to be Rs. 4 then the household consumes 25 
units of A in a month. Now suppose, the price of commodity A goes up from 
Rs.4 to Rs.5. The household will be able to consume only 20 units of commodity 
A.  
To maintain the level of consumption at 25 units of A per month, the household 
needs to have a monthly income of Rs. 125. Thus, we see that with inflation, one 
unit of money purchases a smaller amount of goods than it was doing earlier. In 
other words, with inflation, purchasing power of money goes down. 
In the above example, consumption of the household comprises one commodity 
only. But for a typical household, consumption involves a variety of goods and 
services. As a result, increase in the price of one commodity need not affect 
household consumption adversely if there is a decline in the price of some other 
good. Therefore, to ascertain the effect of inflation we need to take into 
account the change in the prices of all the goods consumed by the household. 
To do that, we need to find the change in the general level of prices. Therefore, 
before defining inflation we discuss the meaning of price level and the 
changes in it. 
 
7.2 MEASUREMENT OF PRICE LEVEL  
We are familiar with the term ‘price’ of a product. What do we mean by the term 
‘price level’? What is the difference between the two? And how do we measure 
price level? These are some of the questions we try to answer in the present 
section. 
In simple terms price is defined as the rate at which goods and services are 
exchanged for money. It is the amount of money received for selling or, paid for 
buying, one unit of a commodity (or services) in an exchange economy. 
The term price level is an aggregate concept. It relates to the price of a basket of 
goods and services. See that we do not refer to the price of a single 
commodity but to a group of goods and services taken as a whole. Therefore, 
when we talk of a change in the price level it is always in reference to a group of 
commodities. Since the prices of commodities differ, in order to measure a change 
in the price level of a group of commodities, it is necessary to use index numbers. 
More specifically, we have to use price index. Let us understand the idea of an 
index number in an elementary form. 
7.2.1  Definition of Index Number 
An index number is a concept which enables us to compare the changes in a 
group of distinct, but related, variables in two or more time periods.  
A price index is used for comparing changes in the general level of prices of a 
group of commodities. Generally a price index refers to changes in the prices 
obtained over time. It is expressed by putting a particular period (called the 
Page 3


 
UNIT 7 INFLATION: CONCEPT, TYPES  
 AND MEASUREMENT
?
 
 
Structure 
7.0  Objectives 
7.1  Introduction 
7.2 Measurement of Price Level  
 7.2.1  Definition of Index Number 
 7.2.2  Types of Index Numbers 
7.3  Inflation Defined 
7.4  Types of Inflation 
 7.4.1  Moderate Inflation 
7.4.2  Galloping Inflation 
7.4.3  Hyper-Inflation 
7.4.4  Stagflation 
7.4.5  Deflation 
7.4.6  Core Inflation 
7.5 Let Us Sum Up 
7.6  Answers/ Hints to Check Your Progress Exercises 
 
7.0  OBJECTIVES 
 
After going through this unit you should be in a position to 
? explain the concept of inflation; 
? explain how inflation is measured;  
? distinguish between various types of price indices to measure inflation; and 
? identify the types of inflation; 
 
7.1  INTRODUCTION 
We come across the term inflation very often in newspapers. The reason why it 
holds such importance is because of its adverse effects on an economy as well as 
people. A question that could arise at this point is in what way does inflation 
affect our everyday life? Let us illustrate with the help of a single household. 
Inflation, in simple words, is a steady rise in the prices of various goods and 
services. Given the level of the money income, a household consumes a group 
of commodities at a given price level. With inflation, the price level goes up. So 
with the same level of money income, the household could consume a smaller 
amount of the commodities than it was consuming earlier. Alternately, to maintain 
the earlier level of consumption this household now needs to have more money. 
                                                           
?
 Dr. Gurleen Kaur, Assistant Professor, Sri Guru Govind Singh College of Commerce, University of   
 Delhi. 
 
74 
 
Inflation and 
Unemployment 
For example, suppose the household has a monthly income of Rs.100, consumes 
the entire income on a single commodity A and does not save anything. If the 
price of commodity A is assumed to be Rs. 4 then the household consumes 25 
units of A in a month. Now suppose, the price of commodity A goes up from 
Rs.4 to Rs.5. The household will be able to consume only 20 units of commodity 
A.  
To maintain the level of consumption at 25 units of A per month, the household 
needs to have a monthly income of Rs. 125. Thus, we see that with inflation, one 
unit of money purchases a smaller amount of goods than it was doing earlier. In 
other words, with inflation, purchasing power of money goes down. 
In the above example, consumption of the household comprises one commodity 
only. But for a typical household, consumption involves a variety of goods and 
services. As a result, increase in the price of one commodity need not affect 
household consumption adversely if there is a decline in the price of some other 
good. Therefore, to ascertain the effect of inflation we need to take into 
account the change in the prices of all the goods consumed by the household. 
To do that, we need to find the change in the general level of prices. Therefore, 
before defining inflation we discuss the meaning of price level and the 
changes in it. 
 
7.2 MEASUREMENT OF PRICE LEVEL  
We are familiar with the term ‘price’ of a product. What do we mean by the term 
‘price level’? What is the difference between the two? And how do we measure 
price level? These are some of the questions we try to answer in the present 
section. 
In simple terms price is defined as the rate at which goods and services are 
exchanged for money. It is the amount of money received for selling or, paid for 
buying, one unit of a commodity (or services) in an exchange economy. 
The term price level is an aggregate concept. It relates to the price of a basket of 
goods and services. See that we do not refer to the price of a single 
commodity but to a group of goods and services taken as a whole. Therefore, 
when we talk of a change in the price level it is always in reference to a group of 
commodities. Since the prices of commodities differ, in order to measure a change 
in the price level of a group of commodities, it is necessary to use index numbers. 
More specifically, we have to use price index. Let us understand the idea of an 
index number in an elementary form. 
7.2.1  Definition of Index Number 
An index number is a concept which enables us to compare the changes in a 
group of distinct, but related, variables in two or more time periods.  
A price index is used for comparing changes in the general level of prices of a 
group of commodities. Generally a price index refers to changes in the prices 
obtained over time. It is expressed by putting a particular period (called the 
 
    75 
 
Inflation: Concept, 
Types and 
Measurement 
‘base period’) equal to 100 and the price level for other periods are expressed 
relative to this base. For example, when we say, the wholesale price index has 
gone up this year with respect to last year, we are taking last year price level as 
the base or, the reference point = 100. With respect to it we measure the change 
in the price level this year. 
The price relative of an individual item is the ratio of its current price to its 
price in a base period. The simplest price index for a given commodity can be 
expressed as 
I
t,o 
= 100 (p
t 
/ p
o
)          … (7.1) 
where p
t 
and p
o 
denote prices in the current period ‘t’ and the base period 
‘0’ 
respectively. 
For instance, if price of a kilo of potato goes up from Rs. 8 in 2017 to Rs. 10 
in 2018, then the price index in this case would be: 
I
2017,2018 
= 100 (10/8) = 125          …(7.2) 
This index shows a 25 per cent increase in the price of potato over the year. In 
other words, you need 25 per cent more money to maintain your consumption of 
potatoes at the same old level. 
7.2.2  Types of Index Numbers 
Index numbers could be of various types, depending upon its purpose and 
methodology. So far as price index is concerned, there are two main types of price 
indices, viz., Wholesale Price Index (WPI) and Consumer Price Index (CPI). Both 
the price indices are different in terms of i) the goods and services included, ii) 
the weights assigned to each category of goods and services, and iii) the prices 
(whether wholesale or retail) taken into account.  
As it is not possible to consider all goods and services (because of time and 
resource constraints), the index numbers are estimated on the basis of a sample 
survey. The numerical value of two price indices will be different depending upon 
three factors, viz., (i) the commodities included in construction of the index, (ii) 
the weights assigned to each commodity, and (iii) the base year of the price index. 
Thus while comparing two price indices we should take into account the above 
factors. We will discuss about index numbers in greater detail later in the course 
‘Statistical Methods for Economics’.  
Wholesale Price Index (WPI) 
The WPI is the price of a representative basket of wholesale goods. This index 
measures the changes in price of goods and services at the wholesale market. In 
India the WPI is published by Office of the Economic Adviser, Department for 
Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, 
Government of India.  
The data are collected at the first point of bulk sale in the domestic market. The 
prices used are ‘wholesale prices for primary articles, administered prices for fuel 
Page 4


 
UNIT 7 INFLATION: CONCEPT, TYPES  
 AND MEASUREMENT
?
 
 
Structure 
7.0  Objectives 
7.1  Introduction 
7.2 Measurement of Price Level  
 7.2.1  Definition of Index Number 
 7.2.2  Types of Index Numbers 
7.3  Inflation Defined 
7.4  Types of Inflation 
 7.4.1  Moderate Inflation 
7.4.2  Galloping Inflation 
7.4.3  Hyper-Inflation 
7.4.4  Stagflation 
7.4.5  Deflation 
7.4.6  Core Inflation 
7.5 Let Us Sum Up 
7.6  Answers/ Hints to Check Your Progress Exercises 
 
7.0  OBJECTIVES 
 
After going through this unit you should be in a position to 
? explain the concept of inflation; 
? explain how inflation is measured;  
? distinguish between various types of price indices to measure inflation; and 
? identify the types of inflation; 
 
7.1  INTRODUCTION 
We come across the term inflation very often in newspapers. The reason why it 
holds such importance is because of its adverse effects on an economy as well as 
people. A question that could arise at this point is in what way does inflation 
affect our everyday life? Let us illustrate with the help of a single household. 
Inflation, in simple words, is a steady rise in the prices of various goods and 
services. Given the level of the money income, a household consumes a group 
of commodities at a given price level. With inflation, the price level goes up. So 
with the same level of money income, the household could consume a smaller 
amount of the commodities than it was consuming earlier. Alternately, to maintain 
the earlier level of consumption this household now needs to have more money. 
                                                           
?
 Dr. Gurleen Kaur, Assistant Professor, Sri Guru Govind Singh College of Commerce, University of   
 Delhi. 
 
74 
 
Inflation and 
Unemployment 
For example, suppose the household has a monthly income of Rs.100, consumes 
the entire income on a single commodity A and does not save anything. If the 
price of commodity A is assumed to be Rs. 4 then the household consumes 25 
units of A in a month. Now suppose, the price of commodity A goes up from 
Rs.4 to Rs.5. The household will be able to consume only 20 units of commodity 
A.  
To maintain the level of consumption at 25 units of A per month, the household 
needs to have a monthly income of Rs. 125. Thus, we see that with inflation, one 
unit of money purchases a smaller amount of goods than it was doing earlier. In 
other words, with inflation, purchasing power of money goes down. 
In the above example, consumption of the household comprises one commodity 
only. But for a typical household, consumption involves a variety of goods and 
services. As a result, increase in the price of one commodity need not affect 
household consumption adversely if there is a decline in the price of some other 
good. Therefore, to ascertain the effect of inflation we need to take into 
account the change in the prices of all the goods consumed by the household. 
To do that, we need to find the change in the general level of prices. Therefore, 
before defining inflation we discuss the meaning of price level and the 
changes in it. 
 
7.2 MEASUREMENT OF PRICE LEVEL  
We are familiar with the term ‘price’ of a product. What do we mean by the term 
‘price level’? What is the difference between the two? And how do we measure 
price level? These are some of the questions we try to answer in the present 
section. 
In simple terms price is defined as the rate at which goods and services are 
exchanged for money. It is the amount of money received for selling or, paid for 
buying, one unit of a commodity (or services) in an exchange economy. 
The term price level is an aggregate concept. It relates to the price of a basket of 
goods and services. See that we do not refer to the price of a single 
commodity but to a group of goods and services taken as a whole. Therefore, 
when we talk of a change in the price level it is always in reference to a group of 
commodities. Since the prices of commodities differ, in order to measure a change 
in the price level of a group of commodities, it is necessary to use index numbers. 
More specifically, we have to use price index. Let us understand the idea of an 
index number in an elementary form. 
7.2.1  Definition of Index Number 
An index number is a concept which enables us to compare the changes in a 
group of distinct, but related, variables in two or more time periods.  
A price index is used for comparing changes in the general level of prices of a 
group of commodities. Generally a price index refers to changes in the prices 
obtained over time. It is expressed by putting a particular period (called the 
 
    75 
 
Inflation: Concept, 
Types and 
Measurement 
‘base period’) equal to 100 and the price level for other periods are expressed 
relative to this base. For example, when we say, the wholesale price index has 
gone up this year with respect to last year, we are taking last year price level as 
the base or, the reference point = 100. With respect to it we measure the change 
in the price level this year. 
The price relative of an individual item is the ratio of its current price to its 
price in a base period. The simplest price index for a given commodity can be 
expressed as 
I
t,o 
= 100 (p
t 
/ p
o
)          … (7.1) 
where p
t 
and p
o 
denote prices in the current period ‘t’ and the base period 
‘0’ 
respectively. 
For instance, if price of a kilo of potato goes up from Rs. 8 in 2017 to Rs. 10 
in 2018, then the price index in this case would be: 
I
2017,2018 
= 100 (10/8) = 125          …(7.2) 
This index shows a 25 per cent increase in the price of potato over the year. In 
other words, you need 25 per cent more money to maintain your consumption of 
potatoes at the same old level. 
7.2.2  Types of Index Numbers 
Index numbers could be of various types, depending upon its purpose and 
methodology. So far as price index is concerned, there are two main types of price 
indices, viz., Wholesale Price Index (WPI) and Consumer Price Index (CPI). Both 
the price indices are different in terms of i) the goods and services included, ii) 
the weights assigned to each category of goods and services, and iii) the prices 
(whether wholesale or retail) taken into account.  
As it is not possible to consider all goods and services (because of time and 
resource constraints), the index numbers are estimated on the basis of a sample 
survey. The numerical value of two price indices will be different depending upon 
three factors, viz., (i) the commodities included in construction of the index, (ii) 
the weights assigned to each commodity, and (iii) the base year of the price index. 
Thus while comparing two price indices we should take into account the above 
factors. We will discuss about index numbers in greater detail later in the course 
‘Statistical Methods for Economics’.  
Wholesale Price Index (WPI) 
The WPI is the price of a representative basket of wholesale goods. This index 
measures the changes in price of goods and services at the wholesale market. In 
India the WPI is published by Office of the Economic Adviser, Department for 
Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, 
Government of India.  
The data are collected at the first point of bulk sale in the domestic market. The 
prices used are ‘wholesale prices for primary articles, administered prices for fuel 
 
76 
 
Inflation and 
Unemployment 
items and ex-factory prices for manufactured products’. One advantage of the 
WPI is that it has a long history, dating back to January 1942, which makes it 
useful for assessing long-term trends in inflation. The WPI also covers a broad 
range of goods, from raw materials to finished manufactures. A major limitation 
of the WPI is that it excludes the services sector which has a major contribution to 
GDP.  
Consumer Price Index (CPI) 
Consumer Price Index measures changes over time in general price level of goods 
and services that households acquire for consumption purposes. The CPI numbers 
in India are widely used i) as a macroeconomic indicator of inflation, ii) as a tool 
for inflation targeting by the RBI, iii) for monitoring price stability by the 
government, iv) for indexation of dearness allowance to employees, and v) as 
deflator for national accounts. The CPI is published by the Central Statistics 
Office (CSO), Government of India. You might have come across the term 
‘headline inflation’ in newspapers and various reports. It refers to inflation based 
on the comprehensive consumer price index.  
Check Your Progress 1 
1)  If a country is experiencing inflation, the change in the nominal national 
product will (choose the correct alternative)  
a) be falling faster than the rate of inflation  
b) equal the change in the real national product  
c) understate the value of national income  
d) overstate the change in the real value of production 
 
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
……………………………………………………………………………… 
 
2)  Distinguish between wholesale price index and consumer price index. 
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
……………………………………………………………………………… 
7.3 INFLATION DEFINED 
With the background of prices and price level in view we go on to the 
definition of inflation. We mentioned earlier that inflation is defined as a 
persistent rise or, a tendency towards persistent rise in the general level of 
prices. The adjective ‘persistence’ has to be taken note of. The reason is, if 
price level goes up today but falls tomorrow then it may not imply inflation, but 
Page 5


 
UNIT 7 INFLATION: CONCEPT, TYPES  
 AND MEASUREMENT
?
 
 
Structure 
7.0  Objectives 
7.1  Introduction 
7.2 Measurement of Price Level  
 7.2.1  Definition of Index Number 
 7.2.2  Types of Index Numbers 
7.3  Inflation Defined 
7.4  Types of Inflation 
 7.4.1  Moderate Inflation 
7.4.2  Galloping Inflation 
7.4.3  Hyper-Inflation 
7.4.4  Stagflation 
7.4.5  Deflation 
7.4.6  Core Inflation 
7.5 Let Us Sum Up 
7.6  Answers/ Hints to Check Your Progress Exercises 
 
7.0  OBJECTIVES 
 
After going through this unit you should be in a position to 
? explain the concept of inflation; 
? explain how inflation is measured;  
? distinguish between various types of price indices to measure inflation; and 
? identify the types of inflation; 
 
7.1  INTRODUCTION 
We come across the term inflation very often in newspapers. The reason why it 
holds such importance is because of its adverse effects on an economy as well as 
people. A question that could arise at this point is in what way does inflation 
affect our everyday life? Let us illustrate with the help of a single household. 
Inflation, in simple words, is a steady rise in the prices of various goods and 
services. Given the level of the money income, a household consumes a group 
of commodities at a given price level. With inflation, the price level goes up. So 
with the same level of money income, the household could consume a smaller 
amount of the commodities than it was consuming earlier. Alternately, to maintain 
the earlier level of consumption this household now needs to have more money. 
                                                           
?
 Dr. Gurleen Kaur, Assistant Professor, Sri Guru Govind Singh College of Commerce, University of   
 Delhi. 
 
74 
 
Inflation and 
Unemployment 
For example, suppose the household has a monthly income of Rs.100, consumes 
the entire income on a single commodity A and does not save anything. If the 
price of commodity A is assumed to be Rs. 4 then the household consumes 25 
units of A in a month. Now suppose, the price of commodity A goes up from 
Rs.4 to Rs.5. The household will be able to consume only 20 units of commodity 
A.  
To maintain the level of consumption at 25 units of A per month, the household 
needs to have a monthly income of Rs. 125. Thus, we see that with inflation, one 
unit of money purchases a smaller amount of goods than it was doing earlier. In 
other words, with inflation, purchasing power of money goes down. 
In the above example, consumption of the household comprises one commodity 
only. But for a typical household, consumption involves a variety of goods and 
services. As a result, increase in the price of one commodity need not affect 
household consumption adversely if there is a decline in the price of some other 
good. Therefore, to ascertain the effect of inflation we need to take into 
account the change in the prices of all the goods consumed by the household. 
To do that, we need to find the change in the general level of prices. Therefore, 
before defining inflation we discuss the meaning of price level and the 
changes in it. 
 
7.2 MEASUREMENT OF PRICE LEVEL  
We are familiar with the term ‘price’ of a product. What do we mean by the term 
‘price level’? What is the difference between the two? And how do we measure 
price level? These are some of the questions we try to answer in the present 
section. 
In simple terms price is defined as the rate at which goods and services are 
exchanged for money. It is the amount of money received for selling or, paid for 
buying, one unit of a commodity (or services) in an exchange economy. 
The term price level is an aggregate concept. It relates to the price of a basket of 
goods and services. See that we do not refer to the price of a single 
commodity but to a group of goods and services taken as a whole. Therefore, 
when we talk of a change in the price level it is always in reference to a group of 
commodities. Since the prices of commodities differ, in order to measure a change 
in the price level of a group of commodities, it is necessary to use index numbers. 
More specifically, we have to use price index. Let us understand the idea of an 
index number in an elementary form. 
7.2.1  Definition of Index Number 
An index number is a concept which enables us to compare the changes in a 
group of distinct, but related, variables in two or more time periods.  
A price index is used for comparing changes in the general level of prices of a 
group of commodities. Generally a price index refers to changes in the prices 
obtained over time. It is expressed by putting a particular period (called the 
 
    75 
 
Inflation: Concept, 
Types and 
Measurement 
‘base period’) equal to 100 and the price level for other periods are expressed 
relative to this base. For example, when we say, the wholesale price index has 
gone up this year with respect to last year, we are taking last year price level as 
the base or, the reference point = 100. With respect to it we measure the change 
in the price level this year. 
The price relative of an individual item is the ratio of its current price to its 
price in a base period. The simplest price index for a given commodity can be 
expressed as 
I
t,o 
= 100 (p
t 
/ p
o
)          … (7.1) 
where p
t 
and p
o 
denote prices in the current period ‘t’ and the base period 
‘0’ 
respectively. 
For instance, if price of a kilo of potato goes up from Rs. 8 in 2017 to Rs. 10 
in 2018, then the price index in this case would be: 
I
2017,2018 
= 100 (10/8) = 125          …(7.2) 
This index shows a 25 per cent increase in the price of potato over the year. In 
other words, you need 25 per cent more money to maintain your consumption of 
potatoes at the same old level. 
7.2.2  Types of Index Numbers 
Index numbers could be of various types, depending upon its purpose and 
methodology. So far as price index is concerned, there are two main types of price 
indices, viz., Wholesale Price Index (WPI) and Consumer Price Index (CPI). Both 
the price indices are different in terms of i) the goods and services included, ii) 
the weights assigned to each category of goods and services, and iii) the prices 
(whether wholesale or retail) taken into account.  
As it is not possible to consider all goods and services (because of time and 
resource constraints), the index numbers are estimated on the basis of a sample 
survey. The numerical value of two price indices will be different depending upon 
three factors, viz., (i) the commodities included in construction of the index, (ii) 
the weights assigned to each commodity, and (iii) the base year of the price index. 
Thus while comparing two price indices we should take into account the above 
factors. We will discuss about index numbers in greater detail later in the course 
‘Statistical Methods for Economics’.  
Wholesale Price Index (WPI) 
The WPI is the price of a representative basket of wholesale goods. This index 
measures the changes in price of goods and services at the wholesale market. In 
India the WPI is published by Office of the Economic Adviser, Department for 
Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, 
Government of India.  
The data are collected at the first point of bulk sale in the domestic market. The 
prices used are ‘wholesale prices for primary articles, administered prices for fuel 
 
76 
 
Inflation and 
Unemployment 
items and ex-factory prices for manufactured products’. One advantage of the 
WPI is that it has a long history, dating back to January 1942, which makes it 
useful for assessing long-term trends in inflation. The WPI also covers a broad 
range of goods, from raw materials to finished manufactures. A major limitation 
of the WPI is that it excludes the services sector which has a major contribution to 
GDP.  
Consumer Price Index (CPI) 
Consumer Price Index measures changes over time in general price level of goods 
and services that households acquire for consumption purposes. The CPI numbers 
in India are widely used i) as a macroeconomic indicator of inflation, ii) as a tool 
for inflation targeting by the RBI, iii) for monitoring price stability by the 
government, iv) for indexation of dearness allowance to employees, and v) as 
deflator for national accounts. The CPI is published by the Central Statistics 
Office (CSO), Government of India. You might have come across the term 
‘headline inflation’ in newspapers and various reports. It refers to inflation based 
on the comprehensive consumer price index.  
Check Your Progress 1 
1)  If a country is experiencing inflation, the change in the nominal national 
product will (choose the correct alternative)  
a) be falling faster than the rate of inflation  
b) equal the change in the real national product  
c) understate the value of national income  
d) overstate the change in the real value of production 
 
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2)  Distinguish between wholesale price index and consumer price index. 
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7.3 INFLATION DEFINED 
With the background of prices and price level in view we go on to the 
definition of inflation. We mentioned earlier that inflation is defined as a 
persistent rise or, a tendency towards persistent rise in the general level of 
prices. The adjective ‘persistence’ has to be taken note of. The reason is, if 
price level goes up today but falls tomorrow then it may not imply inflation, but 
 
    77 
 
Inflation: Concept, 
Types and 
Measurement 
only short-term fluctuations in prices. The term ‘general price level’ is also 
important since, over a period of time, prices of some commodities may have 
gone up while some others may have actually fallen. As a result, on the 
whole, the average of these prices may remain constant or even go down. 
Similarly if the price of a group of commodities, which constitute a small 
fraction of the total value of output of the economy, would go up, then again it 
might not be inflationary as such. That is, the effect of rise in prices of such 
commodities might be too small so as to affect the average price level of all the 
commodities. Thus we see that inflation is a macroeconomic phenomenon and is 
not concerned with the rise in the price of a particular commodity, or, a small 
group of commodities. 
In Section 7.1, it was pointed out how inflation is likely to affect a household 
with fixed money income. In many cases, however, some of the income classes 
actually benefit from inflation or at the least may remain unaffected by it. We 
will discuss the causes and effects of inflation in the next Unit. 
7.4  TYPES OF INFLATION 
On the basis of the severity of inflation or, the rate of acceleration in prices we 
can divide inflation into three different types, viz., moderate, galloping and 
hyper-inflation. Further, there are some other related concepts which we discuss 
below. 
7.4.1 Moderate Inflation 
When the general price level increases slowly but steadily, it is known as 
moderate inflation. In the case of India, the Monetary Policy Committee (MPC) 
resorts to inflation targeting at a rate of 4 per cent per annum. The rate of 
inflation as per targets should not be outside the range of 2 per cent to 6 per cent 
per annum.  
7.4.2  Galloping Inflation 
Steady and fairly high rate of increases in the general price level is known as 
galloping inflation. The rate of inflation runs into two digits (20 per cent, 40 per 
cent, etc.) and sometimes even as high as three digits (i.e., 200 per cent). 
Some Latin American countries like Brazil and Argentina had experienced 
inflation rates of over 100 per cent in the 1970s. 
7.4.3  Hyper-Inflation 
Hyper-inflation is a situation where the rate of inflation is very high. Thus the 
value of money gets eroded rapidly. In order to cope with such a situation, 
households minimize their holdings of local currency. Generally it happens in an 
economy which faces wars and their aftermath, socio-political upheavals or other 
crisis. In these situations it is very difficult to impose tax on the residents by the 
government, which leads to fiscal deficit and government has to finance it 
primarily through money creation rather than imposing taxes or borrowings. In a