Measuring economic performance - Measuring Inflation

Question 1

What is inflation?

Answer 1

A sustained rise in the average price of goods and services over a period of time

Question 2

What is positive inflation?

Answer 2

A sustained rise in the average price of goods and services over a period of time

Question 3

What is negative inflation (deflation)?

Answer 3

A sustained fall in the average price of goods and services

Question 4

What is hyperinflation?

Answer 4

Prices rise extremely quickly and money rapidly loses its value

Question 5

What is disinflation?

Answer 5

The rate of inflation is slowing down, prices are rising but at a slower speed than previously

Question 6

What are the 2 main measures of inflation?

Answer 6

RPI and the CPI

Question 7

Explain the RPI

Answer 7

• Households are surveyed through the Living Costs and Food Survey
• This finds out what people spend their money on e.g petrol, haircuts etc and what proportion of income is spent on these items.
• This works out the weighting of each item, e.g if 20% of income is spent on haircuts then a 20% weighting will be given to haircuts
• A second survey is based on prices, this measures the price of around 700 of the most commonly used goods and services (the basket of goods)
• The items are chosen from the Living Costs and Food Survey
• The price changes in the second survey are multiplied by the weightings from the first survey
• So inflation is the % change to the index number over time eg if the index number rises from 100 to 102, then inflation is 2%

Question 8

Explain the CPI

Answer 8

Same method as RPI, however:

• some items are excluded form the CPI, including mortgage interest payments and council tax
• larger sample of the population used for the CPI
• Follows the same long term trend as the RPI, however CPI tends to be lower than the RPI
• CPI is the official measure of inflation for the UK, many other countries collect data in a similar way to the CPI so it can be used for international comparisons

Question 9

What affects the items in the basket of goods?

Answer 9

Changes in technology, trends and tastes to ensure the basket reflects what the average household might spend its money on

Question 10

What are the limitations of the CPI and the RPI?

Answer 10

• RPI excludes all households in the top 4% of incomes
• Inaccurate information can be given by households in the Living Costs and Food survey
• Basket of goods changes once a year so could miss short term changes in spending habits

Question 11

Why is the CPI and the RPI important for government policy?

Answer 11

• Employers and trade unions can use them as a starting point in wage negotiations
• The gov uses them to decide on increase in state pensions, and other welfare benefits
• Some benefits are index-linked - they rise automatically each year by the same % as the chosen index

Question 12

How is the CPI and the RPi used for measuring changes in the UK’s international competitiveness?

Answer 12

If the rate of inflation measured by the CPI is higher in the UK than other countries that it trades with, then UK goods become less price competitive as they’ll cost more for other counties to buy

So, exports will fall, and imports, which will be made relatively cheaper by domestic inflation, will increase