A rapid increase in the rate of inflation is sometimes attributed to the “base effect”. What is “base effect”?
- It is the impact of drastic deficiency in supply due to failure of crops.
- It is the impact of the surge in demand due to rapid economic growth.
- It is the impact of the price levels of previous year on the calculation of inflation rate.
- None of the statements (a), (b) and (c) given above is correct in this context.
Explanation
Option (c) is correct
- It occurs when price levels in the current year are compared to those of the previous year. E.g.,
- If inflation was high in the previous year, part of the potential increase is already considered, resulting in relatively lower inflation rates for similar price increases in the current year.
- Conversely, if inflation was low in the previous year, even a small rise in the price index will lead to a high current inflation rate.
