Inflation Rate Formula: Consumer Price Index & Calculation

Inflation rate formula is an integral economic indicator that helps in measuring the increase of price in certain products, over some time. Policymakers and economic institutions consider inflation as a significant factor that harms the economic growth, leading to a decrease of purchasing power of the public, though the money supply to the economy increases beyond the optimum level. The inflation rate formula thus helps the concerned authorities to understand the relative level of change in price and take effective steps to keep it under control. A controlled inflation rate will ensure a high standard of living and optimum purchasing power for every kind of consumer.

Read More: GDP

Key Takeaways: Inflation, CPI, Money supply, Purchasing Power, Deflation, Economy 

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Inflation

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Inflation is a situation in which the cost of a group of products appears to increase when compared to that of a period before that. When the cost of the price keeps on increasing, the requirement for money increases, and substantial to that, many economic problems occur.

Causes of Inflation

In terms of macroeconomics, inflation is the situation in which the supply of money into the economy increases beyond the optimum level, creating an abundance of money in the economy. This situation harms a nation’s economy from three perspectives:

1. Reduction in the value of money in the foreign exchange market.
2. Increase price of commodities making it costly to live.
3. Reducing the purchasing power of the currency.

These three situations are inter-connected. When we have more flow of funds into the economy, the cost will increase in the speculation that everyone will have more than enough money during those times. This is one of the reasons why things become costly during festival season. The price increase happens simultaneously with the increase of people’s income. This reduces the purchasing power of our currency i.e. your salary might have increased from Rs.1000 to Rs.1, 500. But at the same time, you would be asked to pay Rs.15 for what you bought for Rs. 10.

Also Read: Disposable Income Formula

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Inflation: Need For Calculation

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Inflation is an economic indicator of some flaws in the structure of the economy. In the long run, inflation will reduce economic growth and will make it difficult for common people to live. It will adversely affect the living standard of the common man.

Most often, the government will be forced to take necessary steps to bring down the inflation rate. The dearness allowance provided to the employees to reduce the effect of inflation on them is a classical example of government intervention in this area. When the economy is facing inflation, the government of a country, together with other economic institutions (like the central bank) take the following measures to reduce the flow of money supply in the economy:

1. Sell Gilt securities (securities issued by government bodies) to collect money from the public.
2. Increase the rate of public lending to collect money in the form of increased interest liability.
3. Increase the rate of interest at which the central bank lends money to other banks.

To operate these measures, the government should be aware of the rate of increase in the price of different commodities. Thus, calculation of the Inflation rate is an inevitable task for the government to take necessary measures. 

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Consumer Price Index (CPI)

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Consumer price index (CPI) is a measure of change in the price level of a basket of commodities purchased by households when compared with that of a base year. Here the ‘basket of commodities’ refers to the group of products that a household buys for their daily purpose. In other words, CPI is the cost of living index that denotes the change in the price level of commodities that the common man purchases, over a period of time.

CPI is often relied on as a component to measure the inflation rate. The annual relative change denotes the direction of inflation in an economy.

Inflation rate formula is given by,

Inflation rate = (change in price / previous year price) x 100

Where change in price = current year price – previous year price

Inflation being an increase in the price, the current year price would be always more than that of a previous year price. The comparison would be made by taking a year’s CPI as the base price (most often, 100) and assessing the change in the price. 

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Things to Remember

• Inflation refers to the increase in the supply of money into the economy beyond the expected limit, which creates an unfavorable imbalance.
• Inflation causes a reduction in the purchasing power of the currency, making the cost of living high and unaffordable to common people.
• The central bank and government of a country take effective steps like open market operation and interest rate adjustments to bring down inflation in the economy.
• CPI (Consumer Price Index) is often relied on by different economic bodies to calculate the inflation rate on an annual basis.
• Inflation rate = (change in price / previous year price) x 100 is a general formula to calculate the inflation rate, where a price change denotes the difference between the current year's price and the previous year's price.
• Deflation is a situation opposite to that of inflation: price of commodities goes on decreasing, which is referred to as a negative form of inflation. 

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