What this lesson teaches
I can define inflation and deflation.
Syllabus K343, 4.7.1. Definitions of inflation and deflation
I can explain how the Consumer Prices Index measures inflation.
Syllabus K343, 4.7.2. Measurement of inflation: measurement of inflation using the Consumer Prices Index (CPI)
Make a guess
The CPI is 113 this year. Does that mean inflation this year was 13%?
- No. Prices are 13% above the base year.
- No. It means prices rose by 113%.
- Yes. A CPI of 113 means 13% inflation.
Show the answer
No. Prices are 13% above the base year.
The CPI compares with a base year set at 100. This year's inflation is the change from last year's index.
Inflation is a sustained rise in the general price level, measured by the change in the Consumer Prices Index.
Inflation is a sustained rise in the general price level over time. It does not mean every price rises. It means prices on average are going up, so each dollar buys less. Deflation is a sustained fall in the general price level.
Inflation is measured with the Consumer Prices Index (CPI). Officials survey households to find what a typical household buys. This list of goods and services is called the basket.
Each item gets a weight based on how much of their income households spend on it. Housing and food get large weights; matches get a tiny one. Prices of the items are checked regularly in many shops.
The cost of the basket in a base year is set to 100. If the index rises to 104 a year later, prices have risen by 4% on average. Inflation rate = (new CPI - old CPI) / old CPI x 100.
- Inflation
- Sustained rise in the general price level.
- Deflation
- Sustained fall in the general price level.
- CPI
- Weighted price index of a typical household basket; base year = 100.
- Inflation rate
- (new CPI - old CPI) / old CPI x 100.
Reading the weighted index
Step 1
Multiply each item's price index by its weight.
Step 2
Add the results: 10,900. Divide by the total weight of 100: the CPI is 109.
Meaning
Prices are 9% higher than in the base year on average. Clothing rose most, but food matters most because its weight is largest.
| Item | Weight | Price index this year | Weight x index |
|---|---|---|---|
| Food | 40 | 110 | 4,400 |
| Transport | 35 | 100 | 3,500 |
| Clothing | 25 | 120 | 3,000 |
| Total | 100 | - | 10,900 |
Worked example: Calculating inflation from the CPI
Suppose the CPI is 110 in 2025 and 113.3 in 2026.
- Change in CPI = 113.3 - 110 = 3.3.
- Inflation rate = 3.3 / 110 x 100 = 3%.
- Interpret: on average, prices in 2026 were 3% higher than in 2025.
- Note: the CPI of 113.3 does not mean inflation was 13.3% this year. It compares with the base year.
Try it step by step
Problem 1
The CPI was 110 in 2024 and 115.5 in 2025.
Show the working
- Change in the CPI: 115.5 - 110 = 5.5 points
- Rate of inflation: 5.5 / 110 x 100 = 5%
- Price of a basket that cost $200 in the first year: $200 x 1.05 = $210
Problem 2
The CPI was 150 in 2024 and 153 in 2025.
Show the working
- Change in the CPI: 153 - 150 = 3 points
- Rate of inflation: 3 / 150 x 100 = 2%
- Price of a basket that cost $200 in the first year: $200 x 1.02 = $204
Problem 3
The CPI was 120 in 2024 and 124.8 in 2025.
Show the working
- Change in the CPI: 124.8 - 120 = 4.8 points
- Rate of inflation: 4.8 / 120 x 100 = 4%
- Price of a basket that cost $200 in the first year: $200 x 1.04 = $208
Watch out for this
If inflation falls from 5% to 2%, prices are falling.
Prices are still rising, just more slowly. Prices fall only when inflation is negative, which is deflation.
Check your understanding
The CPI rises from 120 to 126. What is the rate of inflation?
- 5%
- 6%
- 26%
Show the answer
5%
Right. (126 - 120) / 120 x 100 = 5%.
Check your understanding
A country's Consumer Prices Index was 125 in one year and 130 the next. What was the rate of inflation?
- 4%
- 30%
- 3.8%
- 5%
Show the answer
4%
Right. (130 - 125) / 125 x 100 = 4%.
Check your understanding
The rate of inflation falls from 5% to 2%. What happens to the general price level?
- It stays the same
- It falls by 3%
- It rises faster than before
- It still rises, but more slowly
Show the answer
It still rises, but more slowly
Right. Inflation of 2% means prices are still rising, by less each year.