When looking at inflation, it is important to note that he impact of increases in prices is something that is unique to each individual; dependent on the spending pattern of each individual.
To take a simple example a person who smokes will be affected by increases in tobacco prices but someone who does not is remains unaffected. Increases in fuel prices will have a greater impact on people who have to commute long distances, increases in school fees only affect households with school going children and so forth.
Nevertheless, it is necessary to measure inflation in some way because it affects the well-being or standard of living of people.
In simple terms, a person's standard of living is dependent on two things; their level of income and the buying power of the money that they earn. If prices remain absolutely static, each increase in wages will translate to an increase in disposable income. However if prices rise faster than wages, disposable income will fall. Therefore it is not just wage increases that matter but their relative increase in relation to prices.
It is worth remembering that while wages will rise once; or if one is lucky, twice a year. Prices can rise every day, hence the importance of battling inflation. In order to slay the beast, one must at know it, therefore the need for some way of measuring how prices increases affect the average citizen.
In order to be realistic, an inflation index must be based on the average expenditure of a typical household. Defining this is fraught with difficulties but as there has been enough debate on the subject, statisticians have developed standard methodologies that are broadly acceptable.
A government that wishes to hoodwink its people can do so by changing the methodology. Many analysts have already accused the Government of manipulating the index, so an independent index is welcome. CAL says their index applies to about half of all city dwellers. Excerpts from the report:
CAL developed the Urban Price Index (UPI) to measure the inflation middle class households in cities endure with a greater degree of accuracy than the gov’t’s CCPI. The CAL UPI uses the Laspeyres* method to calculate changes in prices with 2012 as the base year. CAL assumes a monthly income of LKR 80k/household of four with 56% of the income spent on goods in the basket (Jan 2012). The basket includes food and beverages, communication, transportation and energy costs. The CAL UPI shows a 20.6% YoY increase in the costs of living for an urban household while the CCPI depicts only a 9.8% increase. The CAL UPI applies to over half of all city dwellers.
We have assumed a LKR 80k average middle class household income per month, taking two working members in a family of four. This is based on the “Household Income and Expenditure Survey - 2009/10”. CAL has adjusted the 2010 average urban household income of LKR 60k (which represent +54% of Sri Lankan urban households in 2010) to LKR 80k (based on per capita income growth).
CAL UPI Basket
The items in the CAL UPI basket are samples that represent a wider range of goods and services purchased by urban middle class households. There are 30 individual goods and services in the basket. Certain items have been taken as proxies for others not included, but exhibit similar price changes. For example, Chili powder is in the basket, but turmeric and pepper are not. Expenditure on pepper (and other spices not in the basket) is allocated to chili powder proportionate to spending.
CAL UPI is based on the Laspeyres method – CAL’s UPI basket will not change over time and therefore should provide a more accurate depiction of price changes.
The following items have not been considered in the CAL UPI basket.
Health - Primary level universal health care is provided free of charge in Sri Lanka. Further, a majority of the middle class population is covered by insurance schemes paid by the employers.
Education - Sri Lanka has a free, compulsory education system for primary and secondary students up to the age of 18.
Accommodation – For a more objective analysis, we have not included rents.
CAL produces some interesting research and I think they are a pretty decent outfit, check their website. Some of their research is published, although the report on inflation is not. I'm sure they will give you a copy if you call on their office.
Their index may not be perfect but it is definitely a better reflection of the impact of inflation on urban households. I certainly feel the pinch myself, money just seems to evaporate, especially over the past few months. Any comments from readers will be welcome.