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When we talk about the rate of inflation, it often refers to the rate of inflation based on the consumer price index (CPI). The CPI tracks the change in retail prices of goods and services which households purchase for their daily consumption.
To measure inflation, we estimate how much CPI has increased in terms of percentage change over the same period the previous year. If prices have fallen, it is known as deflation (negative inflation). The Central Bank (RBI) pays very close attention to this figure in its role of maintaining price stability in the economy.
The CPI monitors retail prices at a certain level for a particular commodity; price movement of goods and services at rural, urban and all-India levels. The change in the price index over a period of time is referred to as CPI-based inflation, or retail inflation.
Generally, CPI is used as a macroeconomic indicator of inflation, as a tool by the central bank and government for inflation targeting and for inspecting price stability, and as deflator in the national accounts.
CPI also helps understand the real value of salaries, wages, and pensions, the purchasing power of the nation’s currency, and regulating rates. CPI, one of the most important statistics to ascertain economic health, is generally based on the weighted average of the prices of commodities. It basically gives an idea of the cost of the standard of living.
Simply put, CPI specifically identifies periods of deflation or inflation for consumers in their day-to-day living expenses. If there is inflation (when goods and services cost more) the CPI will rise over a period of time. If the CPI drops, that means there is deflation, or a steady reduction in the prices of goods and services.
How is CPI calculated (CPI formula)?
To calculate CPI, multiply 100 to the fraction of the cost price of the current period and the base period.
CPI formula: (Price of basket in current period / Price of basket in base period) x 100