Methods for Determination of Inflation

Read this article to learn about various Methods for Determination of Inflation!

Inflation can be measured by two methods, namely, by determining changes in Price Index Numbers (PINs) and by comparing changes in Gross National Product (GNP) deflator.

Let us discuss these two methods indetailed below.

Through PINs:

Inflation is measured by calculating the changes occurred in PINs over a passage of time. The rate of inflation can be calculated by taking the percentage rate of change in the price index for a given period of time.

The formula used for calculating inflation through PINs is as follows:

Rate of Inflation = PIN_t-PIN_t-1/PIN_t-1 * 100

Where, PIN_t = Price Index Number for year t

PIN_t-1 = Price Index Number for the preceding year (t-1)

The most commonly used price indices for calculating inflation through PINs are as follows:

(a) Consumer Price Index (CPI):

Refers to the price index that measures the change occurred in the prices of consumer goods and services purchased by households over a period of time. The Bureau of Labor Statistics, U.S., has defined CPI as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”

(b) Wholesale Price Index (WPI):

Refers to the price index that is used to estimate the average change in price of goods in wholesale market. W PI is also known as Producers Price Index (PPI). It is different from CPI as the amount paid by consumers does not come directly to producers. This is because of the reason that the revenue generated from the sales of goods and services is subject to price subsidization, profits, and taxes.

(c) Let us understand the computation of inflation rate with the help of PIN. Suppose CPI of a country in February 2007 was 202.416, while in February 2008 was 211.080.

Therefore, the rate of inflation in the country over a period of one year is as follows:

Rate of Inflation = PIN_t-PIN_t-1/PIN_t-1 * 100

Where, PIN_t = 211.080

PIN_t = 202.416

Rate of Inflation = 211.080- 202.416 /202.416 * 100

Rate of Inflation = 4.28%

Through GNP Deflator:

Apart from PIN, GNP deflator is also used for the measuring the rate of inflation. GNP deflator is the measure of price levels of all the final goods and services produced in an economy in a specific period of time.

The formula used for the calculation of GNP deflator is as follows:

GNP Deflator = (Nominal GNP ÷ Real GNP) * 100

Where Nominal GNP = GNP at current prices

Real GNP = GNP at constant prices

The percentage change in GNP deflator of two consecutive years provides the rate of inflation.

Let us calculate the rate of inflation through GNP deflator with the help of an example. Suppose nominal GNP of a country in 2006-2007 is Rs. 1840 thousand crores and real GNP is Rs. 1236 thousand crores. In addition, in 2005-2006, the nominal GNP is Rs. 1560 thousand crores and real GNP is Rs. 1100 thousand crores.

Now, the rate of inflation is calculated as follows:

GNP Deflator (2006-2007) = (1840/1236)* 100 = 149

Now, GNP Deflator (2005-2006) = (1560/1100) * 100 =142

Therefore, the rate of inflation in the country between 2005-2006 and 2006-2007 would be as follows:

Rate of Inflation = [(149-142)/142] *100

= (7/142)* 100

= 4.9%