CDS Economics · Money, Banking and Public Finance
Inflation and Price Indices
The kinds of inflation and their names, how to work out an inflation rate from a price index, what WPI, CPI and core inflation measure, and how inflation is fought.
Why this matters
Fourteen CDS questions, three of them HARD, spread over ten different papers from 2016 (II) to 2025 (II). Two of them are sums on a price index, so the rule that inflation is measured on the previous year is worth a mark every time.
Concept 1 of 4: Kinds of inflation and their effects
Inflation is a lasting rise in the general price level, so each rupee buys less. It starts in one of two ways: buyers want more than the economy can make (demand pulls prices up), or making things gets dearer (costs push prices up). Each mix of prices and growth has its own name.
Definition
The names:
- Inflation: a sustained rise in the general price level.
- Demand-pull: aggregate demand grows faster than supply.
- Cost-push: costs rise, for example crude oil, freight or broken supply chains. Wholesale inflation in 2021-22 was mostly this kind.
- Deflation: a sustained fall in the general price level.
- Disinflation: inflation is still positive but slowing. Reflation: deliberately raising prices and output after a slump.
- Stagflation: slow growth together with rapid inflation (stagnation plus inflation).
- Shrinkflation: the pack gets smaller while the printed price stays the same.
- Effects: the rupee tends to depreciate, exports become less competitive, imports cost more, borrowing becomes dearer, and lenders and bondholders lose in real terms.
| Term | What happens |
|---|---|
| Demand-pull inflation | Demand grows faster than supply |
| Cost-push inflation | Rising costs such as crude oil, freight and supply disruptionsQ CDS 2023 (II): the causes of high wholesale inflation in 2021-22 were crude oil, supply chains and freight, not falling activity. |
| Deflation | Sustained fall in the general price levelQ CDS 2023 (I). |
| Stagflation | Slow growth with rapid inflation |
| Shrinkflation | Smaller pack at the same priceQ CDS 2025 (II). |
| Disinflation | Inflation positive but slowing down |
Practice this concept4 quick reps
The same idea in a real exam question:
CDS · 2021 · CDS (I) 2021 — General Knowledge · Q3Easy
Example 1 · Money, Banking and Public Finance · Inflation and Price Indices
The situation in an economy which is growing slowly along with rapid inflation (rising price level) is called
Deflation is not devaluation or recession
Deflation is a fall in prices. Devaluation is a fall in the external value of a currency, and a recession is a fall in output. Disinflation means prices still rise, only more slowly.
Inflation makes borrowing dearer, not cheaper
With prices rising, the central bank tightens and lenders ask more, so the cost of borrowing rises. Lenders and bondholders lose because they are repaid in money worth less.
Concept 2 of 4: Price index and the inflation rate
A price index tracks the cost of the same fixed basket of goods over time, with the base year set at 100. The inflation rate for a year compares the index with the year just before, not with the base year. So the same rise of 11 points means less inflation when the index is already high.
Definition
The rules:
- A price index measures the change in the average price of a constant basket of goods; the base year is 100.
- The inflation rate for a year = the rise in the index over the previous year, as a percentage of the previous year's index.
- Dividing by the base-year index instead gives the total rise since the base year, not that year's inflation.
Inflation rate
- inflation rate in year t (per cent)
- price index in year t
- price index in the previous year
Worked example
A price index is 150 in one year and 165 the next. What is the rate of inflation?
Practice this conceptself-check · 3 quick reps
The same idea in a real exam question:
CDS · 2024 · CDS (I) 2024 — General Knowledge · Q67Moderate
Example 2 · Money, Banking and Public Finance · Inflation and Price Indices
Which of the following statements is/are correct?
1. A price index captures the change in the average price of a constant basket of commodities.
2. If the price index takes values 100, 110 and 121 in three consecutive years respectively, then the inflation rates in the 2nd and 3rd years are 10% and 21% respectively.
Select the correct answer using the code given below.
Divide by last year, not by the base year
If an index goes from 100 to 125 to 150, inflation in the third year is 25 ÷ 125 = 20%, not 50%. Using the base-year 100 gives the total rise since the base year.
Concept 3 of 4: WPI, CPI and core inflation
India measures prices at two points. The Wholesale Price Index follows prices in bulk trade, so it is mostly about manufactured goods. The Consumer Price Index follows what households pay, including services like rent. Food and fuel prices jump about with the weather and world oil, so 'core' inflation leaves them out to show the steady trend.
Definition
The indices:
- WPI (base 2011-12) weights: manufactured products about 64%, primary articles about 23%, fuel and power about 13%. It covers goods only, no services.
- CPI measures retail prices paid by households and includes services such as housing (rent), health and education.
- The RBI's inflation target is set on CPI (combined): 4%, with a band of 2% to 6%, under the framework adopted in 2016.
- Core inflation = headline CPI inflation minus food and fuel (energy) items.
- Housing in CPI is a core service: it is a service, and core inflation removes only food and fuel.
| Index or measure | Key fact |
|---|---|
| WPI weights (base 2011-12) | Manufactured about 64%, primary about 23%, fuel and power about 13%Q CDS 2024 (I), a HARD question: fuel and power weigh LESS than primary articles. |
| CPI (combined) | The index the RBI targets: 4%, band 2% to 6% |
| Core inflation | Headline CPI minus food and fuel |
| Housing in CPI | A core serviceQ CDS 2025 (I), a HARD question. |
Practice this concept4 quick reps
The same idea in a real exam question:
CDS · 2025 · CDS (I) 2025 — General Knowledge · Q67Moderate
Example 3 · Money, Banking and Public Finance · Inflation and Price Indices
Core inflation is :
Fuel and power is the smallest WPI group
In the WPI, manufactured products (about 64%) outweigh primary articles (about 23%), which outweigh fuel and power (about 13%). A statement that fuel and power outweigh primary articles is false.
Core removes food and fuel, nothing else
Core inflation strips out only the volatile food and fuel (energy) items from CPI headline inflation. It is not built on WPI, and it does not remove all non-food items.
Concept 4 of 4: Fighting inflation and indexation
To cool prices, you take spending power out of the economy: make borrowing dearer, reward saving, lock up bank money, and cut government spending. Some people cannot wait for that to work, so their pay is tied to a price index and rises with it. That is indexation: it protects incomes but does not stop inflation.
Definition
The measures:
- Monetary: raise the repo rate, raise the CRR, sell government securities, offer higher interest on savings and fixed deposits. All of these pull money out of spending.
- Fiscal: cut government spending, raise taxes, reduce the deficit.
- Measures that add to inflation: more government spending, export subsidies, a cut in the CRR.
- Indexation: linking a money payment to a price index so its real value is kept. It is used to fix wage compensation, such as dearness allowance. It protects incomes; it does not control inflation.
| Measure | Effect on inflation |
|---|---|
| Higher interest on savings and fixed deposits | Reduces it (people save instead of spend) |
| Raising the repo rate or CRR | Reduces it |
| Cutting the CRR | Adds to it |
| More government spending | Adds to it |
| Indexation | Protects wages against it; used to fix wage compensationQ CDS 2019 (II): indexation is associated with fixing wage compensation, not with controlling inflation. |
Practice this concept3 quick reps
The same idea in a real exam question:
CDS · 2023 · CDS (I) 2023 — General Knowledge · Q65Moderate
Example 4 · Money, Banking and Public Finance · Inflation and Price Indices
Which one of the following is a measure that can be used by the Government for combatting inflation?
Indexation protects, it does not cure
Indexation raises wages as prices rise, so it protects incomes. It is linked with fixing wage compensation, not with controlling inflation.
Summary — formulas & gotchas at a glance
A revision cheat-sheet for the formulas and gotchas above. Click any concept name to jump back to its full explanation.
Formulas (1)
- Price index and the inflation rate
Inflation rate
Reference tables (3)
Kinds of inflation and their effects6 rows
| Term | What happens |
|---|---|
| Demand-pull inflation | Demand grows faster than supply |
| Cost-push inflation | Rising costs such as crude oil, freight and supply disruptionsQ CDS 2023 (II): the causes of high wholesale inflation in 2021-22 were crude oil, supply chains and freight, not falling activity. |
| Deflation | Sustained fall in the general price levelQ CDS 2023 (I). |
| Stagflation | Slow growth with rapid inflation |
| Shrinkflation | Smaller pack at the same priceQ CDS 2025 (II). |
| Disinflation | Inflation positive but slowing down |
WPI, CPI and core inflation4 rows
| Index or measure | Key fact |
|---|---|
| WPI weights (base 2011-12) | Manufactured about 64%, primary about 23%, fuel and power about 13%Q CDS 2024 (I), a HARD question: fuel and power weigh LESS than primary articles. |
| CPI (combined) | The index the RBI targets: 4%, band 2% to 6% |
| Core inflation | Headline CPI minus food and fuel |
| Housing in CPI | A core serviceQ CDS 2025 (I), a HARD question. |
Fighting inflation and indexation5 rows
| Measure | Effect on inflation |
|---|---|
| Higher interest on savings and fixed deposits | Reduces it (people save instead of spend) |
| Raising the repo rate or CRR | Reduces it |
| Cutting the CRR | Adds to it |
| More government spending | Adds to it |
| Indexation | Protects wages against it; used to fix wage compensationQ CDS 2019 (II): indexation is associated with fixing wage compensation, not with controlling inflation. |
Watch out for (6)
- Deflation is not devaluation or recession→ Kinds of inflation and their effects
- Inflation makes borrowing dearer, not cheaper→ Kinds of inflation and their effects
- Divide by last year, not by the base year→ Price index and the inflation rate
- Fuel and power is the smallest WPI group→ WPI, CPI and core inflation
- Core removes food and fuel, nothing else→ WPI, CPI and core inflation
- Indexation protects, it does not cure→ Fighting inflation and indexation
Test yourself on Money, Banking and Public Finance
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