Wholesale Prices, Consumer Prices and Inflation 

From the man on the street to the highest policy makers, the behavior of prices is of intimate concern. Prices determine the purchasing power of our money incomes and hence have serious implication for our living standards.

Once again there are too many prices to monitor individually. We can group goods and services into broad categories and construct index numbers for each group and monitor the behavior of such price indices. Thus we can have a price index for food items, an index for textiles, and index of industrial raw materials, an index for machinery and equipment, etc. 

The wholesale price index (WPI) and consumer price index (CPI) are two such indices which are extensively used in analysis of price behavior.A simple hypothetical example will serve to illustrate construction of price indices. Suppose there are three items in the consumption basket of a group of customers: rice, milk and cotton cloth. The following table gives their prices in 1981-82 which is taken as the base year, in 1991 which is the 'current year' and their weights in the consumption basket. 

Value of the index is put at 100 for the base year 1981-82. Then the value of the index for 1991 is

             6.80/5.10x100=133.33

That is, the index has increased by 33.33 over its value five years earlier. We say prices have increased by 33%. The weights attached to each item reflect the relative importance of that item in the total collection of items (e.g. in the case of a consumer basket it could be the fraction of total spending devoted to that particular item in the base year).

There are several problems in the construction and use of price indices. These have to do with determination of the weights and changes in these weights over time, changes in quality of goods, appearance of new goods, etc. We will not discuss them here.

Inflation is nothing but increase in the general price level. When one talks of the inflation rate one is referring to the rate of change of one of the price indices mentioned above - usually either the WPI or the CPI. Roughly speaking the rate of inflation indicates the rate at which purchasing power of money is being eroded.

As mentioned earlier, WPI and CPI can exhibit quite different rates of change and occasionally can move in opposite directions. This is because they cover different groups of goods and the weights used are quite different. From the consumers point of view the relevant index is the CPI. In drawing inferences from official statistics on inflation one must be aware of these pitfall