A country's CPI rises from 150 to 159 over a year. What is the rate of inflation?
- Change in CPI = 159 − 150 = 9.
- Divide by the original CPI: 9 ÷ 150 = 0.06.
- Multiply by 100: 0.06 × 100 = 6.
Answer: The rate of inflation is 6%.
Inflation
Economics · Government and the macroeconomy. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.
The idea
Inflation is a sustained rise in the general price level, so money buys less. Deflation is a sustained fall in the general price level. A lower inflation rate does not mean lower prices: prices are still rising, only more slowly.
Inflation is measured with the Consumer Prices Index (CPI), a weighted average of the prices of a basket of goods and services bought by a typical household.
Demand-pull inflation happens when total demand grows faster than output can. Cost-push inflation happens when firms' costs rise, such as wages or imported fuel, and firms pass them on. Inflation hurts savers, lenders and people on fixed incomes, and helps borrowers.
Rules to remember
- Inflation = a sustained rise in the general price level; deflation = a sustained fall in the general price level.
- Inflation rate (%) = change in CPI ÷ original CPI × 100.
- Weighted price index = sum of (weight × price index) ÷ sum of weights.
- CPI of 100 = base year; a CPI of 130 means prices are 30% higher than in the base year.
- Demand-pull: too much total demand. Cost-push: higher costs of production.
- If inflation is above the interest rate, savers and lenders lose real value and borrowers gain.
- Control: higher interest rates, higher taxes or lower government spending for demand-pull; supply-side policy for the long run.
Common mistake
Students subtract the two CPI numbers and call that the inflation rate. A rise from 150 to 159 is 9 index points, but the rate is 9 ÷ 150 × 100 = 6%.
Worked example
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