Inflation
measurement
A-Levels. Economics Y12
Dr Expositor
What is inflation?
Inflation is a persistent increase
of prices in an economy in a
year.
Different
terminology
Y1 Y2
3% Y3 Y4
5% 2%
- 1%
Rising
Disinflation Deflation
Inflation
How is inflation
measured?
Every month, the Office for National Statistics (ONS) looks at around 180,000
prices of 743 items that it puts into its “shopping basket” of goods. These
change as our spending habits change.
CPI: the consumer prices index
CPIH: the consumer prices index plus owner-occupiers’ housing costs
RPI: the retail prices index
Index numbers Car prices:
Y1. £31.000 = 100 8.06
- To make numbers easier
Y2. £33.500 = 108.06 1.19
- To allow for easy and quick data
Y3. £33.900 = 109.35
comparison
Base Year (Year 1) always has a value of 100
Index Number= (Row Number/Base Year Row Number) X100
% = (Difference/original) X 100
CPI (Consumer Price
Index)
➔ Expenditure survey carried out
➔ A consumer basket of ‘most common’
goods/services is formed with average prices
attached
➔ Prices of these goods/services are weighted
based on percentage of income
➔ Weighted prices are added to give total
weighted price of the basket
Y1 Y2
Y3
£3.000 £3.100 £3.150
CPI (Consumer Price
Index)
➔ Base year selected with index value 100
➔ Weighted basket prices converted into index
numbers
➔ % change calculations done to work out annual
inflation rates
➔ Basket is updated yearly (goods/services,
weights)
RPI (Retail Price Index)
It is also used to measure inflation based on the
percentage change in the cost of a basket of retail goods
and series. However, RPI includes more variables-‐ such
as council tax and mortgage interest repayments, which
the CPI does not. Also, the CPI excludes pensioner
households and the lowest and highest-‐income
households.
CPI is the measure currently used by the UK government,
who target an inflation rate of 2%. The Monetary Policy
Committee (MPC) works to keep inflation near 2%, and at
least between 1-‐3%.
Problems with CPI
Unrepresentative for certain people
The top and bottom 4% income brackets are not included, nor are pensioners. Therefore the measure is
not representative for them.
For people with atypical spending patterns, such as vegetarians and non-‐drivers, the CPI is
unrepresentative (e.g. meat and petrol costs form a large part of normal expenditure)
No family has exactly the same spending habit as the basket of goods, so to some extent the measure is
unrepresentative for everyone!
Sampling Problems
Many households do not reply to the survey and those who do might not give accurate information about
all of the members within the household.
There are difficulties in obtaining accurate information on prices.
Changes in taste and fashion
The items in the basket are only changed once a good, but tastes and fashions change more quickly than
this.
Problems with CPI
Substitute Effect
If a price of a good increases, consumers might substitute it for another cheaper, alternative
product. The index does not pick up on this effect because the goods in the basket are only
changed once a year, so the price level is often overstated.
Quality Changes
When the quality of a good changes, the measure breaks down because you are no longer
comparing like to like. For example, a mobile phone in 2012 may cost more but this is not due to
inflation, this is due to better technologies in the 2012 phone.
Mortgage Interest Repayments
CPI does not take into account mortgage interest repayments even though they form a large part of
household expenditure.
Problems with RPI
Mortgage Interest Repayments
RPI accounts for the cost of mortgage interest repayments. Policy-‐makers
raise interest rates to tackle inflation, but the increased interest rates
increases mortgage interest repayments. This makes inflation look worse,
which makes policy-‐makers look incompetent.
Exam Tips: Inflation
Both CPI and RPI are a measure of the general price level-‐ they are not the
rate of inflation. The rate of inflation is found by calculating the % change in
the general price level.
The inflation rate may fall, even though the general price level is still
increasing. This is because the general price level may just be increasing at
a slower rate (disinflation).
Terminolog
y Weighted prices
Inflation Expenditure survey
Disinflation Index
Deflation Percentage change
Price level
Consumer Price Index