UPSC Prelims 2011 · Question 53 of 100
UPSC Prelims 2011 question on Base Effect Inflation
- ExamUPSC CSE
- Year2011
- PaperGeneral Studies Paper I
- SubjectIndian Economy
- TopicInflation
- DifficultyEasy
- TypeDirect
A rapid increase in the rate of inflation is sometimes attributed to the “base effect”. What is “base effect”?
Show answer
Answer: C. It is the impact of the price levels of previous year on the calculation of inflation rate
Verdict
Correct Answer: It is the impact of the price levels of previous year on the calculation of inflation rate
Analysis
The base effect means that the current inflation rate may appear unusually high or low because of the price level in the previous year.
Inflation is usually calculated on a year-on-year basis, comparing current prices with prices in the same period of the previous year.
If last year’s prices were unusually low, even a normal rise this year can show high inflation.
If last year’s prices were unusually high, even a real price rise this year may show low inflation.
So, the base effect is a statistical effect caused by the previous year’s price level.
Example
If onion price was ₹50 last year and becomes ₹100 this year, inflation appears as 100%.
But if onion price was ₹100 two years ago, then the current price may simply be returning to the earlier level. The high inflation is due to the low base of last year.
Extra UPSC info
Base effect is important in analysing CPI and WPI inflation.
It also applies to GDP growth rates.
RBI looks beyond base effect to understand the real inflation trend.
Core inflation excludes volatile food and fuel prices.
Headline inflation includes all items, including food and fuel.
Base effect does not necessarily mean actual demand or supply pressure has increased.
How to crack it
Base effect is the statistical impact of last year’s price level on the current inflation rate. High inflation may sometimes reflect a low previous-year base rather than a fresh price shock.