Definitions & Measurement (Cambridge (CIE) O Level Economics)
Revision Note
Inflation and Deflation
Inflation is the sustained increase in the general price level of goods/services in an economy
The general price level is measured by checking the prices of a 'basket' of goods/services that an average household will purchase each month
This basket of goods is turned into an index and it is called the consumer price index (CPI)
The UK has an inflation target of 2% per annum
Low inflation is better than no inflation as it is a sign of economic growth
Deflation occurs when there is a fall in the general price level of goods/services in an economy
Deflation only occurs when the percentage change in prices falls below zero %
Examiner Tip
Remember that a reduction in the inflation rate from e.g. 5% to 3% means that prices are still rising but rising more slowly (inflation at a decreasing rate is called disinflation)
MCQ will check your understanding of decreasing inflation by asking you questions such as:
In which year are prices their highest?
Y1 Inflation = 5%
Y2 inflation = 3%
Y3 inflation = 1%
Y3 is the answer. Prices are 9% higher in Y3 than at the start of Y1 (5% + 3% + 1%)
Using the Consumer Price Index (CPI) to Measure Inflation and Deflation
Inflation is the sustained increase in the general price level of goods/services in an economy
The inflation rate is the change in general price levels in a given time period
The inflation rate is calculated using an index with 100 as the base year
If the index is 100 in year 1 and 107 in year 2 then the inflation rate is 7%
The consumer price index (CPI) is used to measure inflation
The consumer price index (CPI)
A 'household basket' of 700+ goods/services that an average family would purchase is compiled on an annual basis
A household expenditure survey is conducted to determine what goes into the basket
Each year, some goods/services exit the basket and new ones are added
Goods/services in the basket are weighted based on the proportion of household spending
E.g. More money is spent on food than shoes, so shoes have a lower weighting in the basket
Each month, prices for these goods/services are gathered from hundreds of locations across the country
These prices are averaged out
The price x the weighting determines the final value of the good/service in the basket
These final values are added together to determine the price of the 'basket'
The percentage difference in CPI between the two years is the inflation rate for the period
Worked Example
Using the information in the table, calculate the inflation rate for 2021 if the price of the basket in the base year (2019) was $400
Good | Price 2020 | Price 2021 | Weighting | Basket 2020 (Price x weighting) | Basket 2021 (Price x weighting) |
---|---|---|---|---|---|
Housing, water, electricity, gas | 950 | 1200 | 34% | 323.00 | 408.00 |
Transport | 250 | 325 | 11% | 27.50 | 35.75 |
Food | 500 | 620 | 9% | 45.00 | 55.80 |
Recreation and culture | 300 | 340 | 10% | 30.00 | 34.00 |
Clothing and footwear | 190 | 210 | 5% | 9.50 | 10.50 |
|
|
|
| $435.00 | $544.05 |
Step 1: Calculate the CPI for 2020
Step 2: Calculate the CPI for 2021
Step 3: Calculate the percentage difference between the CPI for 2021 and 2020
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