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Difficulty: MediumInflation Types, Price Indices (CPI, WPI), and Price Control Mechanisms

Evaluate the following statements concerning price index compilation and inflation management mechanisms in India:

I. The Consumer Price Index (CPI) Combined assigns a weight of over 45% to Food and Beverages, whereas the Wholesale Price Index (WPI) assigns a combined weight of less than 25% to food items.
II. The Wholesale Price Index incorporates price changes for service sectors such as healthcare, education, and transport, whereas the Consumer Price Index measures only physical commodities.
III. An increase in the Cash Reserve Ratio (CRR) by the Reserve Bank of India functions as a quantitative monetary policy tool to absorb excess liquidity from commercial banks and control demand-pull inflation.

Which of the statements given above are correct?

  1. I and III onlyAnswer
  2. B
    I and II only
  3. C
    II and III only
  4. D
    I, II and III

Answer

Statements I and III are correct, while statement II is incorrect.
The correct response identifies statements I and III as accurate. In India's price index architecture, CPI Combined features a significantly higher food weight (~45.86%) than WPI (under 25%). Additionally, raising CRR is a standard contractionary monetary instrument used by the RBI to absorb banking liquidity and manage demand-pull inflation. Statement II is false because services are strictly excluded from WPI and included in CPI Combined.

Step-by-Step Solution

1
Analyze Statement I regarding commodity weightages in CPI and WPI baskets.
Statement I is correct. CPI Combined allocates ~45.86% to Food and Beverages, whereas WPI allocates ~15.26% to Primary Food Articles and ~8.45% to Manufactured Food Products, totaling under 25%.
Understanding the difference in basket weights is essential for interpreting retail vs wholesale inflation dynamics.
2
Analyze Statement II regarding coverage of the service sector in price indices.
Statement II is incorrect. WPI tracks price fluctuations only for wholesale tangible goods and excludes services entirely. CPI Combined includes services such as education, healthcare, housing, and transport.
Identifying sector coverage differences prevents misattribution of index scopes.
3
Analyze Statement III regarding monetary policy impacts of CRR on liquidity.
Statement III is correct. Increasing CRR forces commercial banks to park a higher proportion of deposits with the RBI, shrinking lendable bank reserves and mitigating demand-driven inflationary pressure.
Evaluating quantitative monetary policy mechanisms confirms how liquidity absorption impacts demand-pull inflation.

Key Concept

Structural differences between CPI and WPI (weights and service inclusion) and quantitative monetary policy tools (CRR).
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Topics

Inflation Types, Price Indices (CPI, WPI), and Price Control Mechanisms