UPSC Prelims 2011 Q13: Indian Economy – Inflation & Price Indices
- (a) It is the impact of drastic deficiency in supply due to failure of crops
- (b) It is the impact of the surge in demand due to rapid economic growth
- (c) It is the impact of the price levels of previous year on the calculation of inflation rate
- (d) None of the statements (a), (b) and (c) given above is correct in this context
Answer: (c) It is the impact of the price levels of previous year on the calculation of inflation rate
Explanation
What is the 'base effect' on inflation?
Inflation is measured as the percentage change in prices compared with the same period a year earlier (the 'base').
If that earlier period itself had unusually high or low prices, the percentage change this year looks exaggerated or muted, even if nothing dramatic is happening now.
| Option | Verdict | Reason |
|---|---|---|
| (a) Impact of supply deficiency from crop failure | Incorrect | Describes a current supply shock, not a base-year effect |
| (b) Impact of demand surge from economic growth | Incorrect | Describes a current demand factor |
| (c) Impact of the previous year's price level on the inflation calculation | Correct | This is exactly the statistical base effect |
| (d) None of the above | Incorrect | Option (c) correctly defines it |
Example:
| Scenario | Effect on this year's inflation reading |
|---|---|
| Last year's prices were very low | This year's inflation % looks higher even with normal price rises |
| Last year's prices were very high | This year's inflation % looks lower, even if prices are still rising |
Answer: (c) It is the impact of the price levels of previous year on the calculation of inflation rate.
Why each option is right or wrong
- (a) Incorrect. A crop failure is a current supply shock, not the statistical base effect.
- (b) Incorrect. A demand surge is a current-year factor, not about the previous year's price base.
- (c) CORRECT. The base effect is the influence of last year's price level on this year's inflation percentage.
- (d) Incorrect. Option (c) is a correct and standard definition of the base effect.
Key point
Base effect: last year's price level distorts this year's % inflation reading — a statistical/calculation artefact, not a real supply or demand event.
Remember
Base effect = last year's price level distorting this year's inflation %.
Common mistakes
- Confusing the base effect with an actual supply shock like crop failure.
- Thinking 'base effect' refers to demand growth, when it is purely about the reference year's price level.
- Not recognising this as a statistical concept rather than an economic event.
Exam tip
'Base effect' always points to last year's numbers distorting this year's percentage, nothing about today's actual supply or demand.
Sources
- Ministry of Finance, Government of India — Economic Survey 2010–11 (Prices and Monetary Management)
- Reserve Bank of India — Monetary Policy Report (base effects in inflation)