T2: LS8 - Inflation

Question 1

Inflation definition and targets

Answer 1

Inflation: a sustained increase in the general price level of goods and services in an economy over time leading to a decrease in purchasing power of money
- UK target 1%<x>3% (2%)</x>

Question 2

Deflation definition

Answer 2

Deflation: A sustained decrease in the general price level of goods and services in an economy over time leading to risks of low economic growth and recessions.

Question 3

Disinflation definition

Answer 3

Disinflation: A slowdown or decrease in the rate of inflation leading to prices *increasing but at lower rates** than previously.

Question 4

What measures determine how inflation is calculated?

Answer 4

• CPI (consumer price index)
• RPI (Retail price index)

Question 5

What is CPI?

Answer 5

CPI: a measure of the average changes in prices of a ”basket” of goods and services commonly purchased by households which provides an indicator of the overall increase in price level
- Updated annually to reflect consumption habit changes
- Excludes certain costs

Question 6

Formula of CPI index

Answer 6

CPI index: Cost of basket in given year/ cost of basket in base year x 100

Question 7

How to calculate CPI

Answer 7

1) Conduct an ONS survey to find data on consumption habits
2) Identify representative “basket of goods”
3) Assign weighting of each good depending on its proportion and importance in household spending
4) Collect data on prices of each of these items
5) Total the costs of the basket and compare with base year
6 Use index formula or rate formula

Question 8

Formula for rate of inflation on CPI

Answer 8

Inflation rate = (CPI (current) - CPI (base)) * 100 / CPI (base year)

Question 9

What are the limitations of CPI?

Answer 9

T - Time lags
E - Excludes some costs
A - Alternatives
R - Representation:
S - Substitution bias: