How do you see the contribution of any individual element to inflation?

Assume we have two items, A and B, which are priced at Rs. 100 each, which form an index I that has 40% weight to A and 60% of weight to B.

So I = (0.40 x A + 0.60 x B)

Initially, since A and B are Rs. 100, I = 100.

Let’s say, after one year, A becomes 120 (20% inflation) and B becomes 105 (just 5% higher).

So I = (0.40 x 120 + 0.60 x 105) = 111

The Index has gone from 100 to 111, which is 11% inflation.

We need to find out how much of that 11% inflation was because of inflation in A, and correspondingly so for B. Obviously, both will add up to 11%.

The formula to find out is to take the index change (11 points) and find out how much of those points were because of the change in A and the change in B.

The change in A was Rs. 20 (from 100 to 120). The weight of A is 40%, so the effective index impact is: 20 x 0.40 = 8 points.

Therefore A was responsible for 8 points out of the total 11 point change.

So A’s contribution = 8/11 = 73% of the index change.

Put another way, out of 11% inflation, 8% was because of item A.

By elimination B was the remaining 3%. (But you could calculate it the same way too).

If you’re technically aligned, let’s do a formula.

Let’s call an Item’s index now as ItemIndexNow, and a year ago asItemIndexLastYear. The item’s weight in the index is ItemWeight .

Let’s call the overall index (of which Item is a component) asOverallIndexNow, OverallIndexLastYear.

Assume all weights add up to 100. You can substitute 100 for whatever items add up to.

Item’s Contribution = (ItemWeight/100) * (ItemIndexNow – ItemIndexLastYear)/OverallIndexLastYear

All item contributions will add up to Inflation in the index itself. For example, An index that is up by 10% may have contributions from its four subitems, each of which contributes 4%, 3%, 2% and 1% respectively.

 

Rising inflation, leads to increase in expenses, which could lead employers to cut costs and subsequently layoff people or not hire more.

A central bank uses monetary policy as a tool to rein in inflation. Such tools could be raising interest rates.

High unemployment could also indicate a slowdown in economy, and the monetary policy may loosen I.E. Cut interest rates to boost the economy.

If there is greater inflation,there will be rise in market prices and if there is  no subsequent rise in wages it will be difficult for employees to sustain thier livelihood. 

Also the industries may downsize thier employee strength to overcome the stress on rise in wages.This leads to rise in unemployment. 

To control the inflation, the central bank uses monetary policy as an instrument to control the interest rates.