Measuring inflation

Question 1

There are two ways to define inflation

Answer 1

1. inflation = sustained rise in the average price of goods and services over a period of time. taking into account that:
   - prices of some goods might be rising faster than the average
   - some prices might be rising more slowly
   - some prices might even be falling
2. inflation can also = fall in value of money. This means that:
   - fixed amount of money buys less than before
   - purchasing power of money has fallen

Question 2

Inflation can be positive or negative (or 0)

Answer 2

1. inflation = when average price of goods and Serv is rising
2. Sometimes average price will actually be falling. This = negative inflation, or deflation
3. Hyperinflation = when prices rise extremely quickly and money rapidly loses its value
4. rate of inflation is slowing down e.g. from 6% to 4% this = disinflation. Prices still rising but at a slower speed

Question 3

Two main measurements used for inflation

1. Retail Price Index

Answer 3

1. survey carried out
2. first survey is of around 6000 households = Living Costs and Food survey
3. used to find out what ppl spend their money on. Also shows proportion of income spent on these items. Used to work out the relative rating e.g. 20% on transport, then 20% weightin given to transport.
4. Second survey based on prices - measures changes in price of around 700 of the most commonly used goods and services
5. the items are chosen based on Living Costs and Food survey. What is in the basket changes over time - technology, trends and tastes change. Basket reflects what average household might spend their money on.
6. Price changes in the survey are multiplied by the weightings from the first survey. These => into index numbers. Inflation is just the percentage change to the index number over time

Question 4

Two main measurements used for inflation:

2. The consumer price index

Answer 4

CPI calculated similar way to RPI but 3 differences:

1. some items are excluded from CPI, main ones being:
   - mortgage interest payments
   - council tax
2. slightly different formula is used to calculate CPI
3. a larger sample of popln is used for CPI

These diffs => CPI tends to be a little lower than the RPI - exception is when interest rates are very low. Both tend to follow same long-term trend.
CPI is the official measure of inflation in the UK
Many other countries collect data in a similar way to the CPI - used for international comparisons.

Question 5

The CPI and RPI have limitations

Answer 5

The RPI and CPI = v useful but also have limitations:

1. RPI excludes all households from top 4% of incomes. CPI covers a broader range of the popln, doesnt include mortgage interest payments or council tax
2. Information given by households in Living Costs and Food Survey can be inaccurate
3. The basket of goods only changes once a year - so it might miss some short-term changes in spending habits

Question 6

The RPI and CPI are important for Government policy

Answer 6

RPI and CPI are used to help determine wages and state benefits

1. employers and trade unions use them as a starting point in wage negociations
2. government uses them to decide on increases in state pensions, and other welfare benefits
3. Some benefits are index-linked - rise automatically each year by the same percentage as the chosen index

Also used to measure changes in the UK’s international competitiveness:

1. if rate of inflation measured by the CPI is higher in the UK than in other countries it trades withthen UK goods become less price competitive, as they’ll cost more for other countries to buy
2. so exports will fall, and imports, which will be made relatively cheaper by domestic inflation, will increase.