How is Inflation Calculated?

In plain terms, inflation means how much the price level has changed from the previous year. The change in inflation can be calculated by using a suitable price index. Internationally, the two most common price indices used in calculating inflation are CPI and the GDP deflator. Let us take a comparative look these methods.

Consumer Price Index (CPI)
CPI refers to a price index based on the prices of a specified list of consumer goods and services. Tracking these prices provides a measure of inflation. CPI is based on a fixed quantity price index. Some people also consider it a cost of living index. Under this scheme, an index is scaled so that it is equal to 100 at a chosen point in time. All other values of the index are worked out as percentages relative to this.

GDP Deflator
GDP deflator is the other major price index used to measure inflation. This is a price index that shows how much of the change in the GDP from a base year is reliant on changes in the price level.

Whereas the CPI tracks variations in prices of listed commodities, the GDP deflator uses a flexible basket of goods that depends on the quantities of goods and services produced in a given year.

How is inflation calculated in India?

India uses a different price index called the Wholesale Price Index (WPI) to calculate the rate of inflation in our economy. It is quite similar to Consumer Price Index, but uses whole sale prices instead of retail consumer prices.

Wholesale Price Index (WPI)
WPI is the index used to measure changes in the average price levels in the wholesale market. Data on 435 commodities is tracked through WPI, in India, which is an indicator of movement in prices. The Government of India has taken WPI as an indicator of the rate of inflation in the economy.

There are economists who argue that this method is defective, and that it is high time we switched to the Consumer Price Index, which is the indicator adopted by most developed countries.