What Inflation rate indicates is the rate of increase of prices on which it is based. Now if rate is 15% then the prices are 15% higher than last years during the same period. And if it is 5% then prices are 5% higher than last years same period. So suppose last year the Inflation rate was 15% in same period then the price of essential commodities was already increase by 15% from last to last year. And now if it 5% then the price of the product is again increased by 5% of that price last year, which included old 15% growth. Let me explain it by an example:

Suppose price of a product XYZ is Rs.100 in 2009.

Assume Rate of inflation in next year 2010 = 15%
In 2010 the price of product XYZ is = Rs. 115.

Now suppose inflation got down in year 2011 to = 5%
In 2011 the price of same product will be = Rs. 120.75

So actually the rate increase in the year 2010, is consumed in the next years inflation rate calculation. The actual price rise between 2009 - 2011 come out to be 20.75%.

So what is the effect of low inflation. The prices are already on high. The politicians make us fool by saying that the inflation is down now and prices are in control. If you think that 5% is acceptable rate of inflation then in 2 years the price of product XYZ should be Rs. 110.25 and not Rs.120.75.

So actually to contain that extra increase in the inflation in 2010 in above example - the actual inflation rate in 2011 should be -4.13% (yes negative 4.13%). So that the Rs.115 price come down to Rs.110.25 i.e. actual acceptable inflation range.

I hope you got the catch and how the Government makes fool of us.

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