Consumer Price Index + New CPI Series 2015 – UPSC Economy Notes

The Consumer Price Index (CPI) serves as a crucial economic indicator, measuring changes in the prices of goods and services purchased by households. Here are key details about the CPI:

1. Purpose and Scope:
   • The CPI measures price changes by comparing the cost of a fixed basket of commodities, similar to the Wholesale Price Index (WPI). It provides insights into inflation dynamics at the consumer level.
2. Sub-Indexes:
   • Sub-indexes are computed for different categories and sub-categories of goods and services, reflecting their shares in the total consumer expenditures covered by the index.
3. Uses of CPI:
   • The CPI is used to index (adjust for the effect of inflation) the real value of wages, salaries, pensions, and for regulating prices. It is a crucial factor in determining dearness allowance for government employees and wage contracts between labor and employers.
4. Macro-Economic Indicator:
   • Over the years, CPIs have been widely used as a macroeconomic indicator of inflation. Governments and central banks use CPI for targeting inflation and monitoring price stability.
5. National Accounts and Deflators:
   • CPI is used as deflators in the National Accounts along with WPI, contributing to accurate assessments of economic performance.
6. Evolution from Cost of Living Index:
   • Before 1955, CPI numbers were known as ‘Cost of Living Index Numbers.’ The cost of living index is a broader term encompassing changes in prices, consumption habits, and the standard of living.
7. Types of CPIs in India:
   • Presently, multiple consumer price indices are compiled in India, catering to different segments:
     • CPI for Industrial Workers (CPI-IW)
     • CPI for Agricultural Labourers (CPI-AL)
     • Rural Labourers CPI (RL)
     • CPI All India (Urban)
     • CPI All India (Rural)
     • CPI All India (Combined)
     • The Urban Non-Manual Employees (UNME) CPI was discontinued.
8. Basket and Weightages:
   • The baskets and weightages for each item are determined based on surveys of consumption patterns. For example, CPI-IW has a basket of 370 commodities, with weightages assigned based on the consumption patterns of industrial workers.
9. Base Years:
   • The base years for various CPIs vary:
     • CPI-IW: Base year 2016 = 100
     • CPI-AL: Base year 1986-87 = 100
     • CPI-RL: Base year 1986-87 = 100
10. Responsibility and Compilation:
    • The Ministry of Labour is responsible for compiling and releasing data on CPI for Industrial Workers and CPI for rural/agricultural laborers.

CPIs play a pivotal role in economic policymaking, reflecting the impact of inflation on the cost of living for different segments of the population.

New CPI Series 2015: Changes and Methodology

In 2015, the Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation, revised the base year of the Consumer Price Index (CPI) from 2010 = 100 to 2012 = 100. The revision incorporated significant methodological changes reflecting alterations in consumption patterns from 2004-05 to 2011-12. Here are the key changes in the new CPI series:

1. Group Structure:
   • The number of groups increased from five to six. ‘Pan, tobacco and intoxicants,’ previously a sub-group under ‘Food, beverages and Tobacco,’ became a separate group, leading to the renaming of the group to ‘Food and beverages.’
2. Sub-Group Modifications:
   • ‘Egg,’ previously part of the sub-group ‘egg, fish and meat,’ was made a separate sub-group, resulting in the modification of the earlier sub-group to ‘Meat and fish.’
3. Sample Size Increase for House Rent Data:
   • The sample size for collecting house rent data, crucial for the compilation of the House Rent Index, doubled from 6,684 rented dwellings in the old series to 13,368 rented dwellings in the revised series.
4. Weight Distribution:
   • In the new CPI index, the weight of ‘food and beverages’ is 45.86%, and the weight of the ‘fuel and light’ segment is 6.84%. This distribution reflects the changing consumption patterns.
5. Data Collection:
   • Prices are collected from selected towns by the National Sample Survey Office (NSSO) and from selected villages by the Department of Posts. The data collection process ensures a realistic picture of consumer goods and services prices.
6. CPI (Rural and Urban):
   • For CPI (Rural), prices are collected from 1,181 selected village markets covering all districts of the country. For CPI (Urban), all cities/towns with a population of more than 9 lakhs and state/UT capitals not covered therein were selected, and other towns were chosen randomly.
7. Validation Process:
   • The entire process of data validation is carried out using electronic modes of communication. Two independent web portals for Rural and Urban Price Data have been developed by the National Informatics Center (NIC).
8. Release Schedule:
   • The Consumer Price Index is released every month on the 12th day.
9. Adoption by RBI:
   • The Reserve Bank of India (RBI) started using CPI combined as the sole inflation measure for the purpose of inflation targeting. This indicates the significance of the new CPI series in the monetary policy framework.

The revision aimed to align the CPI with changing consumption patterns and improve the accuracy of inflation measurement at both the rural and urban levels.

Difference Between WPI and CPI:

1. Level of Measurement:
   • WPI (Wholesale Price Index): Measures price changes at the wholesale level, reflecting the average change in prices received by producers.
   • CPI (Consumer Price Index): Measures price changes at the retail level, indicating the average change in prices paid by consumers.
2. Baskets, Commodities, and Weights:
   • WPI: Calculated with a basket of goods and services at the wholesale level, with its own set of commodities and weights.
   • CPI: Calculated with a different basket of goods and services at the retail level, with its own set of commodities and weights. The composition of the baskets varies significantly.
3. Food Inflation Impact:
   • CPI: Reflects food inflation more prominently, given its higher weight in the CPI basket compared to WPI.
   • WPI: Food articles and manufactured food products have a combined weight that is lower than the weight of the food group in CPI.
4. Role of Middlemen:
   • Considerable divergence due to the presence of middlemen between wholesalers and consumers, each contributing their own margins to the final retail price.
5. Regional and Tax Variations:
   • Consumer prices vary regionally and between rural and urban areas due to factors such as consumer preferences, supplies, purchasing power, state taxes, and logistical costs.
6. Composition of Baskets:
   • CPI: Includes services like housing, education, medical care, and recreation, which are not part of the WPI basket.
   • WPI: Represents manufacturing inputs and intermediate goods influenced by global factors, not directly consumed by consumers and not covered by the CPI basket.
7. Effect of Indirect Taxes:
   • WPI: New WPI series excludes indirect taxes.
   • CPI: Captures taxes, adding to the variation between the two indices.

The divergence between WPI and CPI arises from the distinct nature of their baskets, the weights assigned, the impact of taxes, and the additional costs associated with logistics and middlemen. While WPI primarily focuses on the wholesale level and production costs, CPI provides a more comprehensive picture of retail-level price changes affecting consumers directly.

Consumer Price Index for Industrial Workers (CPI-IW):

The CPI-IW, compiled and disseminated by the Labour Bureau on a monthly basis, is designed to measure changes in the retail prices of a fixed basket of goods and services consumed by an average working-class family. This index plays a crucial role in guiding policy formulations and is used for fixing and revising wages, as well as regulating dearness allowances for a large number of manual workers and Central/State Government employees.

Key Features of the New CPI-IW Series (2016=100):

1. Base Year Revision:
   • The base year of the existing CPI-IW series was revised from 2001=100 to a more recent base year of 2016=100.
2. Sector Coverage:
   • The new series covers industrial workers from seven sectors: Factories, Mines, Plantation, Railways, Public Motor Transport Undertakings, Electricity Generating and Distributing Establishments, and Ports & Docks.
3. Wider Coverage:
   • The new series has a wider coverage in terms of sample size, number of centers, markets/outlets, and items compared to the previous series.
4. Centers Coverage:
   • The total number of centers covered increased to 88 under the 2016 series, compared to 78 centers in the 2001 series.
5. Sample Size Increase:
   • The sample size for the conduct of the Working Class Family Income and Expenditure Survey, used for deriving weighting diagrams, increased to 48,384 families from 41,040 in the 2001 series.
6. Retail Price Data Collection:
   • The number of selected markets for the collection of retail price data increased to 317 markets under the 2016 series, up from 289 markets covered in the 2001 series.
7. Items in the Index Basket:
   • The number of items directly retained in the index basket increased to 463 items, compared to 392 items in the 2001 series.
8. State/UT Coverage:
   • The number of States/UTs covered increased to 28 under the 2016 series, compared to 25 in the 2001 series.
9. Group Level Weights:
   • Changes in group level weights were observed under the new series. The weight of Food & Beverages declined over time, while the weight of the Miscellaneous group (Health; Education & Recreation; Transport & Communication; Personal Care & Effects; Household Goods & Services, etc.) increased substantially. The weight of the Housing Group also reported an increasing share over time.

The revision and expansion of the CPI-IW series aim to capture the latest consumption patterns of working-class families, providing a more accurate representation of inflation impacts on this demographic group.

Base Effect:

Base effect refers to the impact that changes in the Consumer Price Index (CPI) or Wholesale Price Index (WPI) in the base month have on the year-on-year (YoY) inflation rate. It is essentially the contribution to changes in the annual rate of measured inflation stemming from abnormal changes in the price index during the base period.

Key Points:

1. Definition:
   • Base effect is the influence that significant changes in the CPI or WPI during the base month exert on the calculated YoY inflation rate.
2. Effect on Inflation Rates:
   • When there are substantial changes in the price index during the base period, it can significantly impact the YoY inflation rate. This effect is important to consider when interpreting inflation data.
3. Abnormal Changes in the Base Period:
   • Base effects result from abnormal changes in the price index during the base period. These abnormal changes can distort the comparison of current inflation rates with those of the previous period.
4. Distinguishing Factors:
   • It is crucial to distinguish whether changes in inflation are driven by actual price changes in the current month or are influenced by extreme price changes in the base period.
5. Example:
   • For instance, if there was WPI deflation (negative inflation) in April-July 2020, it would create a relatively low base for the index numbers in the same months in 2021. As a result, even if the ground-level prices indicate moderate inflation, the YoY inflation rate may appear higher due to the low base effect.
6. Application to Growth Rates:
   • Base effect is not unique to inflation rates; it applies to growth rates and other comparative rates as well. It’s a factor to be considered when assessing changes over different periods.

In summary, base effect is a phenomenon that arises when abnormal price changes in the base period distort the interpretation of inflation rates, especially in YoY comparisons. It is an important consideration for analysts and policymakers when making sense of economic indicators.

Relevance of WPI and CPI Indices:

1. WPI (Wholesale Price Index):
   • Useful for Industrialists: WPI is particularly valuable for industrialists because it includes commodities significant to industrial processes, and they typically make wholesale purchases.
   • Industrial Focus: Commodities like machinery and chemicals, crucial for industrial operations, are part of the WPI basket. Industrialists, who often engage in wholesale transactions, find WPI more relevant.
2. CPI (Consumer Price Index):
   • Consumer-Centric: CPI, especially the CPI All India (Combined), is highly relevant for consumers. It reflects the changes in prices of goods and services consumed by households.
   • Inflation Targeting: RBI (Reserve Bank of India) uses CPI, specifically CPI Combined, for inflation targeting. It is a key indicator for monetary policy decisions.
3. Differences in Coverage:
   • WPI vs. CPI Basket: The CPI basket is more focused on goods and services directly consumed by households. It may not include certain industrial inputs like machinery and chemicals, which are part of the WPI basket.
   • Electricity Tariffs: The price of electricity in CPI is based on consumer tariffs, whereas industrial tariffs may differ. This difference in electricity pricing is a consideration for businesses.
4. Price Index for Services:
   • Inclusion of Services: The new CPI series incorporates some major services like medical care, education, recreation, and communication. However, it may not cover all service sectors comprehensively.
   • Exclusion of Some Services: Notably, services such as trade, hotels, financing, insurance, real estate, and business services are not covered in the CPI basket.
5. Service Price Index (SPI):
   • Initiative for Service Sector: Recognizing the gap in service sector coverage, the Department of Industrial Policy and Promotion (DIPP) formed an Expert Committee to advise on the development of the Service Price Index (SPI).
   • Committee’s Role: Chaired by Prof. C. P. Chandrasekhar, the committee plays a crucial role in providing technical guidance for the development of the SPI and addressing related issues.

In conclusion, while WPI is instrumental for industrialists and businesses dealing with wholesale transactions, CPI, especially CPI Combined, is a key indicator for consumers and plays a central role in RBI’s inflation targeting. The evolving landscape includes efforts to develop a Service Price Index to better capture price movements in the service sector.

Engel’s Law on Family Expenditure: Engel’s Law, proposed by Ernst Engel in 1857, is a key economic principle related to family expenditure. It states that as family income increases, the percentage of income spent on food decreases, even though the actual amount spent on food may increase. This law highlights a shift in spending patterns as households move from lower to higher income levels. While basic necessities like food constitute a larger proportion of the budget for lower-income families, higher-income families allocate a smaller percentage of their budget to food, allowing for increased spending on other goods and services.

Bennett’s Law: Bennett’s Law complements Engel’s Law and emphasizes a specific aspect of dietary preferences. It states that as income increases, the proportion of the budget spent on “starchy-staples” decreases. This law suggests a tendency for consumers to diversify their diets, particularly by incorporating more protein-rich foods, as their income rises. The desire for dietary variety and a shift towards higher-quality and more diverse food items is reflected in Bennett’s Law.

Relevance in India: These laws are particularly relevant in the context of India, where rapid economic growth since the mid-2000s has been accompanied by changes in dietary patterns. As income levels rise, there is often a shift in consumption preferences towards a more diverse and protein-rich diet. Understanding these principles helps economists and policymakers analyze the evolving nature of household spending and its implications for food consumption patterns.

FAQs

Q: What is CPI?

A: CPI stands for Consumer Price Index, a measure used to evaluate changes in the price level of a basket of consumer goods and services over time. It reflects inflation or deflation trends and is a crucial indicator for assessing economic stability and adjusting policies.

Q: What is the significance of the New CPI Series 2015?

A: The New CPI Series 2015 is an updated version of the CPI that incorporates changes in consumption patterns and expenditure weights, reflecting more accurately the current consumer behavior and market dynamics. It provides a more relevant and precise measure of inflation, aiding policymakers, economists, and businesses in making informed decisions.

Q: How does the New CPI Series 2015 differ from the previous versions?

A: The New CPI Series 2015 incorporates an updated basket of goods and services, revised weighting schemes, and improved methodologies for data collection and analysis. These enhancements ensure that the CPI accurately reflects contemporary consumer preferences and spending patterns, offering a more reliable gauge of inflationary pressures.

Q: How does the New CPI Series 2015 impact consumers?

A: The New CPI Series 2015 enables consumers to better understand changes in the cost of living and make informed decisions regarding budgeting, saving, and spending. By providing a more accurate representation of inflation, it helps individuals and households adapt to economic fluctuations and plan their financial activities more effectively.

Q: What are the implications of the New CPI Series 2015 for policymakers and businesses?

A: For policymakers, the New CPI Series 2015 serves as a crucial tool for formulating monetary and fiscal policies, as it provides a more reliable basis for assessing inflationary pressures and economic stability. Businesses can utilize this updated CPI to adjust pricing strategies, forecast consumer demand, and optimize resource allocation, enhancing their competitiveness in the market.

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