Inflation, CPI & RPI (AQA Level 3 Mathematical Studies (Core Maths))
Revision Note
Written by: Jamie Wood
Reviewed by: Dan Finlay
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
Potential positives of Inflation | Potential negatives of Inflation |
|---|---|
Reducing debt As money is worth less, debt is reduced in real terms. | Reduced purchasing power Less can be bought with the same amount of money, so quality of life may decrease if incomes do not increase. |
Stimulating the economy If inflation is predictable, there is incentive to make purchases sooner rather than later. | Uncertainty and risk High and/or unpredictable inflation can create uncertainty for businesses and consumers. |
Economic growth Moderate inflation can be a sign of a growing economy. If consumer spending increases then businesses may raise prices. | Lower value from savings Interest rates will often not keep up with inflation, so money in savings loses value over time. |
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
Worked Example
Laurinda has been given a pay rise for her work in the past year.
Her salary has changed from £28 000 to £28 840.
The rate of inflation nationally for the year was 3.9%.
Decide if Laurinda has been given a "real terms" pay rise, relative to inflation.
Calculate how much Laurinda's new salary should be, if it were to increase in-line with inflation
A multiplier of 1.039 can be used to find an increase of 3.9%
£28 000 × 1.039 = £29 092
This is greater than Laurinda's new salary
An alternate method is to calculate the percentage increase Laurinda has received
£28 840 ÷ £28 000 = 1.03
This is equivalent to a 3% increase, which is smaller than the 3.9% inflation
Laurinda has not been given a "real terms" pay rise
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
Month | CPI |
|---|---|
Jan 2023 | 126.4 |
Feb 2023 | 127.9 |
Mar 2023 | 128.9 |
Apr 2023 | 130.4 |
May 2023 | 131.3 |
Jun 2023 | 131.5 |
Jul 2023 | 130.9 |
Aug 2023 | 131.3 |
Sep 2023 | 132.0 |
Oct 2023 | 132.0 |
Nov 2023 | 131.7 |
Dec 2023 | 132.2 |
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
Worked Example
The table below shows CPI (2015 = 100) and RPI (1987 = 100) for January 2021 and January 2022.
CPI (2015 = 100) | RPI (1987 = 100) | |
|---|---|---|
Jan 2021 | 109.0 | 294.6 |
Jan 2022 | 114.9 | 317.7 |
(a) Calculate the percentage change between January 2021 and January 2022 for each price index.
Find the 2022 value as a percentage of the 2021 value
Then write this as a percentage change
For CPI first
114.9 ÷ 109.0 = 1.05412844...
This is an increase of 5.412844...%
For RPI next
317.7 ÷ 294.6 = 1.078411405...
This is an increase of 7.8411405...%
CPI has increased by 5.41% (3.s.f)
RPI has increased by 7.84% (3.s.f)
(b) Explain why these two indexes do not show the same percentage change.
CPI and RPI use a different selection of goods and services to track
For example, RPI also includes housing costs
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