Price indexes and inflation
Calculate a percentage change in the general price level and interpret what it does and does not show.
What you will learn
- Calculate inflation from a price index.
- Distinguish inflation from slower inflation.
An index compares levels
A consumer price index summarises price changes for a weighted basket. The percentage change between two periods measures the change relative to the earlier index. An index increase of five points is not automatically a five-percent increase.
Inflation is an increase in the general price level. Deflation is a fall in that level. A lower positive inflation rate means prices are still rising, but more slowly; this is disinflation.
Interpret carefully
A price index does not tell you whether every household faces the same cost increase. Spending patterns differ, so an average basket may not match an individual household.
A higher price level alone does not establish a recession or an increase in unemployment. Those require different evidence.
Worked example
A price index rises from 120 to 126. Find the percentage increase.
Show the worked solution
- The increase is 6 index points.
- Divide by the earlier value: 6/120=0.05.
- Convert to a percentage.
Answer 5%
Common mistakes
- Use the old index as the denominator.
- A fall in inflation from 8% to 3% does not mean prices fell.
What can you explain now?
An index falls from 200 to 196. What is the rate of change?
Compare with the explanation
−2%
The change is −4; dividing by 200 gives −0.02, a fall in the price level.
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