India is a mixed economy in which both public and private institutions coexist. Today, most countries, including India, are trying to strengthen market economies where private institutions predominate. In a market economy, the decisions are taken by the millions of firms and households. Firms decide whom to hire and what to make. Households decide which firms to work for and what to buy with their incomes. These firms and households interact in the market, where prices guide their decisions.
A market is an institutional arrangement under which buyers and sellers can exchange goods or services at a mutually agreeable price. In a market system, everything has a price, which is the value of the good in terms of money. Prices represent the terms on which people and firms voluntarily exchange different commodities. Prices coordinate the decisions of producers and consumers in a market. Higher prices tend to reduce consumer purchases and encourage production. Lower prices encourage consumption and discourage production. Prices are the balance wheel of the market mechanism. By matching sellers and buyers (supply and demand) in each market, a market economy simultaneously solves the three fundamental problems of any economy namely, what to produce, how to produce, and for whom to produce.
In a dynamic world, prices of commodities and services do not remain constant, they fluctuate. This movement of prices in the economy for a period of time is measured by price index. The price index is an indicator of the average price movement over time of a fixed basket of goods and services. The constitution of the basket of goods and services is done keeping into consideration whether the changes are to be measured in retail, wholesale or producer prices, etc. e basket will also vary for economy-wide, regional, or sector specific series. At present, separate series of index numbers are compiled to capture the price movements at retail and wholesale level in India.
There are four main series of price indices compiled at the national level. Out of these four, Consumer Price Index for Industrial Workers (CPI- IW) and Consumer Price Index for Agricultural Labourers /Rural Labourers (CPI - AL/ RL), are consumer price indices. The Wholesale Price Index (WPI) number is a measure of wholesale price movement for the economy. Some States also compile variants of CPI and WPI indices at the State level. Inflation rates calculated in India on the basis of the movement of the Wholesale Price Index (WPI). WPI is an important measure to monitor the dynamic movement of prices. As WPI captures price movements in a most comprehensive way, it is widely used by Government, banks, industry and business circles. Important monetary and fiscal policy changes are often linked to WPI movements. Similarly, the movement of WPI serves as an important determinant in formulation of trade, fiscal and other economic policies by the Government of India. The WPI indices are also used for the purpose of escalation clauses in the supply of raw materials, machinery and construction work.
Indicators of Price Change
(i) Wholesale Price Index (WPI)
WPI is a weighted average of price relatives of commodities, classified into three categories namely, primary, manufacturing and fuel and power. Prices considered for WPI are wholesale prices. Services are not included in WPI.
(ii) Consumer Price Index (CPI)
CPI is a weighted average of price relatives of a basket of goods and services consumed by the people. In India, CPI for Industrial Workers (CPI- IW) and CPI for Agricultural Labourers / Rural Labourers (CPI ï¿½ AL/ RL), are estimated separately. Retail prices are considered for CPI..
(iii) GDP Deflator
The GDP deator, also called the implicit price deator for GDP, This deed as the ratio of nominal GDP to real GDP:
GDP Deflator = (Nominal GDP/ Real GDP)
Nominal GDP measures the value of the output of the economy at current prices. Real GDP measures output valued at constant prices. The GDP deflator measures the price of output relative to its price in the base year.
Written by princy