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Have you seen recently in the news that we will have to pay more for the same amounts of gas to fill our cars’ tanks and that heating is becoming more and more expensive? This is due to inflation. But, what is inflation and how does it affect our income? Can it be controlled? You will find answers to these questions in what follows and you will learn how inflation impacts the economy.
Inflation is the situation when the general price levels of goods and services increase and the value of money decreases in the economy. As a result of inflation, one may require more money to buy goods or services compared to what one would have paid in the past. Basically, it means that the same amount of money can now get you fewer units of a good or service than before.
These goods and services include:
When the prices of goods and services go down in the economy and the comparative value of money increases, it is called Deflation.
There are two major forces that impact the economy and increase the price level of goods and services:
Cost-push inflation occurs when the cost of production increases. This results in an increase in the final price of goods and services.
As a result of the rising price of wheat flour in the UK, the cost of wholemeal wheat loaves of bread has increased. Hence, the increase in the cost of wheat pushes the prices of loaves of bread to increase too.
Demand-pull inflation occurs when there is a high demand for goods and services but not enough aggregate supply. When aggregate supply and aggregate demand for goods and services don't match, there is a rise in the price of those goods and services.
When the demand for the new iPhone is very high but the rate of supply is comparatively low, the price of the new iPhone will increase causing demand-pull inflation.
The rate of inflation is measured in many different ways in different countries. The three most commonly used methods to measure the inflation rate are described below:
The RPI is now an old method of inflation calculation. The RPI is calculated using the arithmetic mean. It includes housing costs, mortgage interests, council taxes, and rent.
The RPI method is based on two surveys to collect the data.
The RPI is calculated by measuring the changes in the prices of items in the baskets of goods.
The most commonly used method of inflation calculation across the globe is the CPI. The CPI is calculated using a geometric mean. CPI measures the percentage change in the prices of a basket of goods and services of household goods.
It takes into account the prices of primary consumer goods that include transportation, medical care, and food. The CPI is calculated in a similar way to the RPI. However, it has a few differences:
The WPI takes into account the wholesale prices of the goods and services. This method calculates the goods’ rate of inflation at the wholesale stage and before they reach retail. The goods considered here are sold in bulk and are between business to business.
The WPI usually takes into account commodity prices. It is also calculated as the percentage change in the prices of goods and services compared to the base year.
Figure 2. Consumer and Retails Price Indices in the UK 200-2021, Source: Office for National Statistics, ons.gov.uk, StudySmarter Original
Most governments in the world use the CPI method to measure inflation. The CPI measures the percentage change in the prices of a basket of goods and services of household goods.
These goods and services are divided into eight categories: housing, apparel, transportation, medical, recreation, food and beverages, education, and other goods and services.
CPI = Cost of Market basket in the given year X 100
Cost of the market basket in the base year
The baskets are regularly updated to calculate the CPI, as there are changes in the trends, technology, etc.
Although the CPI index is the most common way of calculating inflation, it has a few problems and disadvantages.
As we already saw, inflation can be caused by cost-push inflation and demand-pull inflation. Inflation can be controlled with the following measures:
RPI - Retail Price Index
CPI - Consumer Price Index
WPI - Wholesale Price Index.
The RPI is calculated using an arithmetic mean. It includes housing costs, mortgage interests, council taxes, and rent.
The CPI measures the percentage change in the prices of a basket of goods and services of household goods.
The WPI calculates the rate of inflation at the stages of wholesale and before they reach retail.
Inflation can be measured using different indices:
RPI - Retail Price Index
CPI - Consumer Price Index
WPI - Wholesale Price Index
In the UK inflation is measured using the CPI method. The CPI measures the percentage change in the prices of a basket of goods and services. These goods and services are divided into eight categories: housing, apparel, transportation, medical, recreation, food and beverages, education and other goods and services.
Inflation can be measured using different indices:
RPI - Retail Price Index
CPI - Consumer Price Index
WPI - Wholesale Price Index
The CPI measures the percentage change in the prices of a basket of goods and services of household goods. It takes into account the prices of primary consumer goods and includes transportation, medical care, and food.
Inflation is the situation when the general price levels of goods and services increase and the value of money decreases in the economy. As a result of inflation, one may require more money to buy goods or services compared to what one would have paid in the past. Basically, it means that the same amount of money can now get you fewer units of a good or service than before.
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