Home Consumer resources Explaining relative prices – the key to inflation data

Explaining relative prices – the key to inflation data

0

Changes in relative prices benefit some and harm others for a given level of retail price inflation. Suppose that if relative food prices increase, this changes the distribution of expenditure, with the poor having to spend more of their income on food if income does not increase sufficiently. A rising relative price also sends a signal to suppliers to increase production to take advantage of higher prices. Changes in relative prices therefore tend to lead to changes in the allocation of resources in the economy.

Since 2012, the base year of the consumer price index, the price of the meat and fish group has increased the fastest, an increase of more than 110% compared to other food products. There has been a rapid increase in the relative prices of vegetables, oils and fats, and spices.

There are interesting differences between rural and urban areas in terms of absolute price changes that influence relative prices. In the case of meat and fish, their prices increased by similar proportions in rural and urban India. In contrast, retail vegetable prices increased much more in urban areas, suggesting additional transport and storage costs and greater accessibility for urban consumers. As a result, the relative price of meat and fish, an essential source of protein for many, compared to vegetables, has risen more sharply in rural areas than in urban areas.

In contrast, the largest relative price decline was observed for sugar in both rural and urban India. In fact, the absolute price of sugar has only increased by 20% in a decade. Similarly, the relative price of cereals has fallen compared to fruits and vegetables. Among services, transportation, communications, and recreation and entertainment have seen their prices fall relative to health care and education.

A rise in relative food prices raises the cost of living for poor families more than inflation indicates. Additionally, with carbohydrates and sugar becoming more affordable than protein, there is an incentive to consume more of it. Similarly, a rise in the relative price of health care hurts the poor more, given the high out-of-pocket expenditure on health care in India. While the Center’s effort to provide free health insurance to the poor is noteworthy, increasing the supply of quality health services appears to be lagging.

The poor end up saving less or having to reduce their consumption of certain other items if the increase in their income is insufficient to compensate for the increase in prices. Since late 2014, rural real wage growth has virtually stagnated in India. Real wages are nominal wages adjusted for inflation. It also requires higher public transfers and subsidies to relatively poor people.

When consumer prices rise, the gains are shared between retailers and producers. It depends on the increase in wholesale prices of a product compared to an increase in retail prices. If the wholesale price increases faster than the retail price, producers tend to make higher gains relative to retailers and vice versa if input costs do not increase. This also matters for the reallocation of production resources.

In India, the wholesale price index includes the prices of food, fuel and manufactured goods, but not services. Among the product categories for which both price indices are readily available or can be calculated, retailers recorded higher price increases than producers in eight of the 14 product lines. This is particularly the case for meat and fish, which have seen the highest price increase. Indeed, despite the rise in the relative prices of meat and fish, the incentive for producers to increase supply seems limited. Similarly, in footwear and clothing, retail prices rose faster than wholesale prices.

On the other hand, the prices that producers receive for vegetables have increased much more than the increase in the retail price. To a lesser extent, the same is true for fruits and cereals. The prices that producers receive for cereals are, however, less volatile and only move upwards compared to fruits and vegetables since cereals benefit from support prices and do not require cold storage. This is also the case with sugar cane. Despite the fall in the relative price of sugar due to an oversupply, the price signal is not transmitted to sugar cane producers who benefit from a guaranteed minimum support price.

In services, the health and education sectors are more regulated than communication and entertainment. More extensive and unpredictable regulation makes it more difficult to reallocate resources in response to changes in relative prices. Furthermore, when production needs to be increased or moved, it requires investment, not just reorganization of existing resources. Moreover, in agriculture, the suitability of land for the type of crop determines whether and how quickly change can occur.

While the Reserve Bank of India can and should keep an eye on retail inflation, the reallocation of resources in response to relative prices depends more on government regulations and policies, the volume of investment required and the ease of change of production and sector. India needs to make faster progress in this regard.

Vidya Mahambare and Praveen Kumar are Professor of Economics and Director (Research) respectively and graduates of the Great Lakes Institute of Management, Chennai.

Catch all the trade news, market news, breaking news and latest updates on Live Mint. Download the Mint News app to get daily market updates.

More less

To subscribe to Mint Bulletins

* Enter a valid email

* Thank you for subscribing to our newsletter.

Post your comment