We often hear about inflation and how it affects the price of everyday items. To measure this inflation we use index point. Thus, to understand the inflation it is important to understand index numbers. There are two types of index numbers used generally. They are CPI and WPI. Today we are going to understand only CPI that is consumer price index.
Consumer Price Index
There is a huge difference in the consumption pattern of people in society. Thus, to understand this pattern, we need to understand the prices that are paid by these sections. The index numbers that we use generally fail to depict the changes. Thus, we use the consumer price index (CPI) to understand this pattern.
An average change in price by a specific type of customer is explained by the consumer price index. Thus, it is done for the services and goods that are consumed in the current year. CPI is also known as the cost of living index. This is because when the price level changes, consumption pattern also changes.
Thus, this change alters the cost of living. There are three groups for CPI is measured. They are agricultural labors, Industrial workers, and urban non-manual labors.
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Significance of CPI
CPI depicts how the changes in price levels affect heterogeneous customers. Also, it helps the government in formulating fiscal policies, price policy, tax policy, etc.
Thus, it helps the government in calculating the risks taken for development without changing the cost of living. Also, the state government uses CPI to decide the wage structure. Additionally, this helps them to construct the dearness allowance of the workers.
Also, CPI is a measure of how accurate the power of a currency is. This is based on the fact that any change in price triggers consumption. Furthermore, national income is also calculated using the consumption expenditure.
This is on the fact one’s expenses is another person’s income. Thus, CPI acts as an income deflator nationally.
Limitations of CPI
Like index numbers, there are difficulties related to the CPI also. In a vast country like India, different people have different standards of living. Thus, one CPI cannot justify the entire diversity. Also, the price indices used for CPI are done using retail prices.
However, retail prices vary from shop to shop and store to store. Thus, the choice of retails price changes the entire result. So, the general retail price needs to be chosen. Also, this should prevail in all the market.
The major difficulty that lies in is the change in consumption factor. Thus, it means that there can also be variation in consumption among a specific group of people.
Also, for an individual, the consumption ratio can vary to a large extent. Thus, because of these reasons, the change in the cost of living is questionable while calculating the CPI.
There are two methods used to calculate the CPI. They are a family budget method and aggregative expenditure method.
Practice Questions on Consumer Price Index
Q. The index that is used to calculate inflation in India is called
A. Consumer price index
B. Wholesale price index
C. Commodity price index
D. Both A and B
Answer: D. Both A and B
Q. What prices are measured using the consumer price index?
A. Goods only
B. Services only
C. Both goods and services
D. None of the above
Answer: C. Both goods and services