Base effect

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The Base effect[1] relates to inflation in the corresponding period of the previous year, if the inflation rate was too low in the corresponding period of the previous year, even a smaller rise in the Price Index will arithmetically give a high rate of inflation now. On the other hand, if the price index had risen at a high rate in the corresponding period of the previous year and recorded high inflation rate, a similar absolute increase in the Price index now will show a lower inflation rate now.

An illustration of the base effect would be like: Price Index 100 goes to 150, and then to 200. The initial increase of 50, gives the percentage increase as 50% but the subsequent increase of 50 gives the percentage increase as 33.33%. This happens arithmetically as the base on which the percentage is calculated has increased from 100 to 150.

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