Inflation, CPI & RPI (AQA Level 3 Mathematical Studies (Core Maths))

Inflation

What is inflation?

• Inflation is the increase in prices of goods and services over time

  • Deflation is when prices decrease over time

• As inflation occurs, money is worth less than it was in the past

  • The same amount of money will now buy less, or has less "purchasing power"

• For example:

  • In 1980 the average UK house price was £23 500

    • By 2000 it was £81 600

    • By 2020 it was £229 800

  • In 1980 the average price for a loaf of bread was 35 pence

    • By 2000 it was 52 pence

    • By 2020 it was 104 pence

• The rate of inflation will be different for different products and services

  • This is partly due to different levels of supply and demand over time

• Economists tend to agree that moderate, predictable inflation is a positive for an economy overall

  • Potential positives and negatives of inflation are summarised in the table below

What does "in real terms" mean?

• The phrase "in real terms" is often used to take inflation into account

• Consider a sum of money put into a savings account for 1 year with a 3% interest rate per year

  • If inflation is equal to 3% for that year, the money is worth the same in real terms

  • If inflation is more than 3% for that year, the money is worth less in real terms

  • If inflation is less than 3% for that year, the money is worth more in real terms

CPI & RPI

What is CPI?

• CPI is the Consumer Price Index

• CPI quantifies how prices are changing over time

• The index considers the total cost of a "basket" of over 700 goods and services including:

  • Food and drink

  • Clothing and shoes

  • Electricity and gas

  • Furniture and household goods

  • Recreational activities

• The items in the basket are reviewed regularly, as well as their weightings

  • The weightings consider how much an item should affect the index

    • This is informed by the proportion of money consumers spend on these items

  • E.g. Petrol has a higher weighting than tea

• CPI is measured relative to a base year which is given an index of 100

  • For the table below, 2015 is the base year (CPI=100)

  • The table shows CPI each month during 2023

• The figure of 130.9 in July 2023 means that prices are 30.9% higher than in 2015 (the base year)

• Values can also be compared to each other, rather than just the base year

  • This is how inflation is calculated between two points in time

  • Comparing CPI in January 2023 (126.4) to December 2023 (132.2)

    • 132.2 ÷ 126.4 = 1.045886076...

    • This means there was a 4.59% (3.s.f.) increase in CPI between January and December in 2023

• CPI is also tracked over the long term

  • The graph below shows how the value of CPI has changed between 1989 and 2024, using 2015 as a base year

What is RPI?

• RPI is the Retail Price Index

• RPI works in a very similar way to CPI, but is an older version and has now been replaced by CPI for most purposes

  • RPI is still used by the government for some purposes for historic reasons

  • E.g. There are pension structures that are linked with RPI

• It also uses a basket of goods and services, but these are slightly different to those included for CPI

  • RPI includes several measures relating to housing costs

    • E.g. Mortgage interest payments, house depreciation, and buildings insurance

  • CPI includes university accommodation fees, stockbrokers' charges, and tuition fees for foreign students

    • None of these are included in RPI

• RPI is usually expressed relative to January 1987 (the base year)

• When both use the same base year, RPI is generally higher than CPI

• There are other indexes which are also used to measure inflation

  • CPIH is similar to CPI but includes the costs of housing too

  • HPI is the House Price Index