Base Effect

Posted in Finance, Accounting and Economics Terms, Total Reads: 1650

Definition: Base Effect

Base Effect indicates the change in the inflation rate in the current period with respect to the base period.

A base year is set which is assigned a value of Price Index=100. Now on the basis of rise and fall in price index as compared to the base year, inflation is calculated.

For example, considering the price index in 2001(base year) was 100 and the index rose to 110 in 2002 so the inflation rate becomes 10% .Now in 2003 price index was 120,so as per the base year the inflation rate becomes 20% but the inflation rise is 9.09% compared to previous year.

The drawback with this is that it makes the inflation look too high or too low even if the price index rise has been same as the base changes.

if the price index had risen at a higher rate in the corresponding period of the base year showing a high inflation rate, an exact same increase in the price index now  will show a lower inflation rate. 

Hence, this concludes the definition of Base Effect along with its overview.

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