A rapid increase in the rate of inflation is sometimes attributed to the "base effect". What is "base effect"?

A) It is the impact of drastic deficiency in supply due to failure of crops.
B) It is the impact of the surge in demand due to rapid economic growth.
C) It is the impact of the price levels of the previous year on the calculation of inflation rate.
D) None of the statements given above is correct.

The 'base effect' refers to the impact that the price levels of the previous year (the base period) have on the calculation of the current inflation rate [3]. Inflation is typically measured as a percentage change in a price index over a twelve-month period [2]. If the price index was abnormally low in the corresponding month of the previous year—perhaps due to a temporary slump in economic activity or a supply glut—even a moderate increase in current prices will result in a high percentage growth rate [3]. Conversely, a high price level in the base year can lead to a lower reported inflation rate in the current year, even if prices are still rising [1]. This phenomenon can cause volatility and distortion in headline inflation figures, making it difficult to assess underlying price trends without considering the starting point of the calculation [3].

Sources

1. [1] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > WHAT IS BASE YEAR OR BASE EFFECT? > p. 65
2. [2] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > CHAPTER SUMMARY > p. 76