Inflation and Index Numbers

A statistical tool that measures the changes in the magnitude of a group of related variables is called an index number.

The inflation and index numbers keep track of the changes in the overall price level in an economy. The ratio of the cost of a commodity or a group of many commodities at one time to the cost of one commodity or many commodities at some other time is represented by the inflation and index numbers. 

What is the Inflation Index Number?

A tool used to get an idea of the broad price changes in the economy over a period is called the inflation index number. To understand the inflation index number, understanding the index ratio number is important. Index numbers represent the ratio between the cost values of one item to the cost value of another item. The index number model is used in many economics and finances, such as the stock market, wage levels, and labour yields.

There are several methods to calculate the index number, but every method should be interpreted carefully and precisely. The choice of formula largely depends on the question of interest. An inflation index number is used to track the inflation rate, and it also measures changes in the general cost level over a while. It is called inflation when the cost level rises.

On the other hand, when the cost level falls, it is called deflation or negative inflation.

What is the cost inflation index?

With an increase in the price of goods, the purchasing power of money falls. The cost inflation index is the ratio of the estimate of the increase in the cost of goods and services year-to-year because of inflation. The calculation of the cost inflation index is made to match the costs to the inflation rate.

Cost inflation index chart

CPI, or consumer price index, is used to calculate a long-term capital gain from a sale or transfer of capital assets. It is the best method for calculating inflation and gives the idea to consumers about the changes in price in future. The CPI is used in the Cost Inflation Index to calculate inflation to see the long term capital gain from a sale or transfer of capital assets.

Cost inflation takes CPI for the given year for non-manual employees for the preceding year. The capital asset’s price is supposed to rise in the years between its purchase & its sale. Selling that asset will give the owner a significant net amount.

The cost inflation index chart for FY2020-21 is 301. The following is an example of the cost inflation index chart of the last five years: 

How to calculate the inflation index number?

The inflation index number for a year is calculated by taking the price index from the year in interest. Then, the base year is subtracted from it and dividing the whole thing with the base year. After the inflation index calculation, the answer is multiplied by 100 to get the percent change in inflation. 

Now, let’s see the formula for calculating inflation-  

Inflation= (price index in the current year- price index in the base year)/ price of the base year X 100.    

Indexed cost of the acquisition cost 

Indexed cost of acquisition is an amount that bears the acquisition cost in equal proportions. The cost inflation index of the year when the asset is transferred is bared to the cost inflation index for the first year when the asset was held by the asset holder or assessee.

Index acquisition cost calculation=purchase price of the property X cost inflation index of the financial year in which property is sold/ cost inflation index for purchase year of the property.  

Conclusion

Index numbers represent the ratio between the cost values of one item to the cost value of another item. In many areas of economics and finances, the index number model is used, like in the stock market, wage levels, and labour yields. With the increase in the price of goods, the power of purchasing falls. The Cost Inflation Index is used to estimate the increase in the cost of goods and services year-to-year because of inflation.  

Take the price index from the year of interest and then minus the base year, and divide it by the base year is how the inflation index is calculated.