Inflation
Inflation is the general increase in prices over time or the general decrease in the value of
money
Deflation is the general decrease in prices over time or the general increase in the value of
money
Disinflation is when prices are increasing but the rate of inflation is decreasing
The management of inflation, i.e. price stability, is one of the four main macroeconomic
objectives.
Inflation, deflation and disinflation are all examples of changes in the general or aggregate
price level.
Shrinkflation
Product size decreases but price stays the same
How is inflation measured?
The aggregate or general price level is in effect, the weighted average price of all consumer
goods and services
The UK inflation rate is published every month by the ONS
The inflation rate is rate of the difference in average retail prices paid by the average
household (i.e. consumers) in the latest month and the same month in the previous year
(e.g. January 2019 vs. January 2018).
The inflation rate is expressed either as a percentage change, or as a price index, such as the
Consumer Price Indices (CPI and CPIH) or the Retail Price Index (RPI)
What are the price indices used for?
Price indices are important as they measure the rate of inflation, the management of which
is one of the government’s four main macroeconomic objectives.
Price indices are also used to determine annual increases in state (and private) benefits such
as pensions.
They are also widely used by firms as a basis for increases in wages and in prices such as
train fares.
Average prices and the average household
In theory, changes in the aggregate price level should be calculated from tracking the retail
prices of all goods and services bought by all households from all shops and other points of
sale (e.g. the internet)
This is simply not practical! Consequently, the ONS measures changes in the prices of goods
and services from an “imaginary shopping basket” that is a representative sample of the mix,
value and quantities of the goods and services bought by UK households.
Once compiled, the price changes in this sample are computed to give an overall rate of
inflation.
The “average” shopping basket
Consumer price inflation is calculated by tracking changes in the prices of an imaginary
“shopping basket” containing a representative sample of 700 goods and services bought by
households.
For around 520 items, 100,000 price checks are made in around 20,000 shops and retail
outlets in 150 locations across the UK.
, Some prices from large retailers are collected centrally and the average price derived from
the retailers’ market shares. For the remaining 180 items, prices are identical throughout
the UK and these are collected centrally by the ONS using the internet, phone or email.
A weighted basket
The contents of the CPIH basket are weighted to reflect the relative value of different groups
of products and services bought by consumers.
These are the twelve categories. Which do you think are the five largest categories which in
total account for around 70.5% of the value of household spending?
Household services and housing- 33%
Recreation and culture- 11%
Transport- 11%
Food and non-alcoholic drinks- 9%
The basket is kept up to date
Each category contains numerous products and services; these are often a range of products
(e.g. “bread” will include several types of bread) or can be individual products if they are
significant part of household spending (e.g. petrol, electricity)
The contents of the basket are revised every year (in mid-March) to reflect what households
buy. Some goods and services that are less popular are replaced with those that are more
popular.
Some individual products or services are removed but remain in the basket within a broader
group; other individual products, previously within a group are “promoted” as a separate
item.
Statistical adjustments are made to account for the changes in the basket to provide a
consistent time series.
Examples of changes to the 2021 CPI basket
Inflation is the general increase in prices over time or the general decrease in the value of
money
Deflation is the general decrease in prices over time or the general increase in the value of
money
Disinflation is when prices are increasing but the rate of inflation is decreasing
The management of inflation, i.e. price stability, is one of the four main macroeconomic
objectives.
Inflation, deflation and disinflation are all examples of changes in the general or aggregate
price level.
Shrinkflation
Product size decreases but price stays the same
How is inflation measured?
The aggregate or general price level is in effect, the weighted average price of all consumer
goods and services
The UK inflation rate is published every month by the ONS
The inflation rate is rate of the difference in average retail prices paid by the average
household (i.e. consumers) in the latest month and the same month in the previous year
(e.g. January 2019 vs. January 2018).
The inflation rate is expressed either as a percentage change, or as a price index, such as the
Consumer Price Indices (CPI and CPIH) or the Retail Price Index (RPI)
What are the price indices used for?
Price indices are important as they measure the rate of inflation, the management of which
is one of the government’s four main macroeconomic objectives.
Price indices are also used to determine annual increases in state (and private) benefits such
as pensions.
They are also widely used by firms as a basis for increases in wages and in prices such as
train fares.
Average prices and the average household
In theory, changes in the aggregate price level should be calculated from tracking the retail
prices of all goods and services bought by all households from all shops and other points of
sale (e.g. the internet)
This is simply not practical! Consequently, the ONS measures changes in the prices of goods
and services from an “imaginary shopping basket” that is a representative sample of the mix,
value and quantities of the goods and services bought by UK households.
Once compiled, the price changes in this sample are computed to give an overall rate of
inflation.
The “average” shopping basket
Consumer price inflation is calculated by tracking changes in the prices of an imaginary
“shopping basket” containing a representative sample of 700 goods and services bought by
households.
For around 520 items, 100,000 price checks are made in around 20,000 shops and retail
outlets in 150 locations across the UK.
, Some prices from large retailers are collected centrally and the average price derived from
the retailers’ market shares. For the remaining 180 items, prices are identical throughout
the UK and these are collected centrally by the ONS using the internet, phone or email.
A weighted basket
The contents of the CPIH basket are weighted to reflect the relative value of different groups
of products and services bought by consumers.
These are the twelve categories. Which do you think are the five largest categories which in
total account for around 70.5% of the value of household spending?
Household services and housing- 33%
Recreation and culture- 11%
Transport- 11%
Food and non-alcoholic drinks- 9%
The basket is kept up to date
Each category contains numerous products and services; these are often a range of products
(e.g. “bread” will include several types of bread) or can be individual products if they are
significant part of household spending (e.g. petrol, electricity)
The contents of the basket are revised every year (in mid-March) to reflect what households
buy. Some goods and services that are less popular are replaced with those that are more
popular.
Some individual products or services are removed but remain in the basket within a broader
group; other individual products, previously within a group are “promoted” as a separate
item.
Statistical adjustments are made to account for the changes in the basket to provide a
consistent time series.
Examples of changes to the 2021 CPI basket
