1. Inflation
October 2016
Learning objective: To understand the definition of inflation and be able to evaluate which parts of the economy lose or win as a result of inflation
References: Edexcel getting started guide section 2.1.2
Anderton chapter 30 p

2. Inflation
“a sustained increase in the general price level leading to a decrease in the purchasing power of money”
1985
2015
Household income : 10,000/yr
Cost of Living: 10,000/yr
Household income: 30,000/yr
Cost of Living: 30,000/yr
(focus on whole economy - not one particular industry – it’s possible for individual industry to experience decreasing prices when the economy is experiencing overall inflation)

3. Inflation Target
- gov’t has set a target of 2% for inflation – this is deemed the best rate for a stable economy (higher than that and inflation can have negative effects; lower than that can mean a stagnant economy)
As prices rise, the value of money falls – the same money can’t buy as much as it used to.
The Bank of England is charged with the responsibility of controlling inflation

4. Measuring Inflation: Consumer Prices Index
Food and Living Costs Survey – find out what households spend their money on (average basket of goods – approx. 700 – basket updated annually)
Weights Determined – goods that we spend a higher proportion of income on get more importance in the basket
Prices Checked – from stores across the UK
Weights Applied – price changes multiplied by the weight of that item
Total CPI – weighted price changes are totalled to give this month’s figure for price inflation

5. Calculating CPI Product Weight Price Change Weighted Price Change Fuel
10% X
+ 20% =
+ 2%
Food
25%
- 10%
- 2.5%
Motoring 5% 0%
Leisure
20%
+ 5%
+ 1%
Clothing
+ 6%
+ 0.6%
Housing
30%
+ 1.5%
100%
Total CPI:
+ 2.6%

6. CPI calculation exercise:
Food: +2%
Alcohol, tobacco: +6.1%
Clothing: -0.5%
Housing, utilities: +2.2%
Furniture & household: 1.7%
Health: +2.4%
Transport: +2.5%
Communication: +3.4%
Recreation: +1.2%
Education: +3.2%
Restaurants, hotels: +3.0%
Misc: +2.3%

7. Product Division
% Price Change
Weight in basket
Weighted price change

8. A few definitions:
Inflation – sustained increase in the general price level
Deflation – a decrease in the general price level (negative inflation)
Disinflation – a decrease in the rate of inflation (eg. Inflation was 2.5% last month and it is now 2%)

9. Other Measures of Inflation
RPI – slightly different contents of basket & method of measurement includes mortgage interest payments, excluded from CPI - excludes richest households & pensioners - uses an arithmetic mean – CPI uses a geometric mean
PPI – Producer Price Index – costs faced by producers (a leading indicator of RPI)
Deflator (We saw this during Economic Growth work). Change in overall price level –
Nominal GDP x 100 = Real GDP
Deflator

10. Calculating Index Numbers
Index number X = nominal X x 100 base year
Year
Price level
Index
250
250/250 x 100 = 100 1
275
275/250 x 100 = 110 2
302.5 3
317.6 4
381.2