Defining Inflation
There are two acceptable definitions for inflation in A Level economics. I prefer the first of the two however both definitions are acceptable key term definitions to use.
What is deflation?
deflation is any period in which the general price level is falling. It is associated with an increase in the purchasing power of money. The inflation rate, measured by CPI is a negative value.
- A sustained increase in the general price level of an economy over a period of time, or,
- A decrease in the purchasing power of money
What is deflation?
deflation is any period in which the general price level is falling. It is associated with an increase in the purchasing power of money. The inflation rate, measured by CPI is a negative value.
Measuring Inflation - CPI
Inflation is caluclated using CPI - The Consumer Price Index.
There are three simple steps in calculating the CPI rate.
There are three simple steps in calculating the CPI rate.
- The ONS create a 'basket' of the most frequently bought goods and services in the UK.
- The basket of goods changes each year to reflect changing consumer spending habits. The changes to the basket of goods can be found here.
- The ONS then track the price changes of the basket over time.
- The price changes are 'weighted' into a final average CPI rate. The weighting means that those goods we spend more on have a heavier weighting on the final index. e.g. if food accounts for 40% of consumer spending in the basket then 40% of the price change will be included in the final CPI rate.
Inflation in the UK
Inflation is a real problem for the UK right now (2022) You can see in the diagram above that we are currently experiencing inflation of around 7% which is huge. Another way to think about this is if you purchased a pair of earbud style earphones for £100 last year those same earbuds would now cost you £107.
Whilst that seems ok, its only £7 from an economist's point of view you need to consider that this price increase happens to every single purchase made this year. The difference overall can be huge.
Here is a blog post that outlines some of the current causes of inflation in the UK.
Whilst that seems ok, its only £7 from an economist's point of view you need to consider that this price increase happens to every single purchase made this year. The difference overall can be huge.
Here is a blog post that outlines some of the current causes of inflation in the UK.
Causes of inflation
What is Demand Pull Inflation?Demand pull inflation occurs when the aggregate demand (AD) curve shifts to the right. When combined with a long run aggregate supply curve this casues inflation, measured on the y-axis of our macroeconomcs diagrams.
Any increase in the following AD factors causes an increase in demand pull inflation
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What is Cost Push Inflation?Cost push inflation occurs when firms' costs increase and these are then passed onto consumers in the form of higher prices. The best diagram to show this is the short run aggregate supply/aggregate demand diagram (SRAS/AD). This type of inflation is causing the current cost of living crisis (2023) in the UK. Both Brexit regulations and the war in Ukraine are increasing firms' costs.
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