Inflation October 2016 Learning objective: To understand the definition of inflation and be able to evaluate which parts of the economy lose or win as a result of inflation References: Edexcel getting started guide section 2.1.2 http://qualifications.pearson.com/content/dam/pdf/A%20Level/economics-a/2015/teaching-materials/Getting_Started_Guide_new.pdf Anderton chapter 30 p201-208

Inflation “a sustained increase in the general price level leading to a decrease in the purchasing power of money” 1985 2015 Household income : 10,000/yr Cost of Living: 10,000/yr Household income: 30,000/yr Cost of Living: 30,000/yr (focus on whole economy - not one particular industry – it’s possible for individual industry to experience decreasing prices when the economy is experiencing overall inflation)

Inflation Target - gov’t has set a target of 2% for inflation – this is deemed the best rate for a stable economy (higher than that and inflation can have negative effects; lower than that can mean a stagnant economy) As prices rise, the value of money falls – the same money can’t buy as much as it used to. The Bank of England is charged with the responsibility of controlling inflation

Measuring Inflation: Consumer Prices Index Food and Living Costs Survey – find out what households spend their money on (average basket of goods – approx. 700 – basket updated annually) Weights Determined – goods that we spend a higher proportion of income on get more importance in the basket Prices Checked – from stores across the UK Weights Applied – price changes multiplied by the weight of that item Total CPI – weighted price changes are totalled to give this month’s figure for price inflation

Calculating CPI Product Weight Price Change Weighted Price Change Fuel 10% X + 20% = + 2% Food 25% - 10% - 2.5% Motoring 5% 0% Leisure 20% + 5% + 1% Clothing + 6% + 0.6% Housing 30% + 1.5% 100% Total CPI: + 2.6%

CPI calculation exercise: Food: +2% Alcohol, tobacco: +6.1% Clothing: -0.5% Housing, utilities: +2.2% Furniture & household: 1.7% Health: +2.4% Transport: +2.5% Communication: +3.4% Recreation: +1.2% Education: +3.2% Restaurants, hotels: +3.0% Misc: +2.3%

Product Division % Price Change Weight in basket Weighted price change

A few definitions: Inflation – sustained increase in the general price level Deflation – a decrease in the general price level (negative inflation) Disinflation – a decrease in the rate of inflation (eg. Inflation was 2.5% last month and it is now 2%)

Other Measures of Inflation RPI – slightly different contents of basket & method of measurement - includes mortgage interest payments, excluded from CPI - excludes richest households & pensioners - uses an arithmetic mean – CPI uses a geometric mean PPI – Producer Price Index – costs faced by producers (a leading indicator of RPI) Deflator (We saw this during Economic Growth work). Change in overall price level – Nominal GDP x 100 = Real GDP Deflator

Calculating Index Numbers Index number X = nominal X x 100 base year Year Price level Index 250 250/250 x 100 = 100 1 275 275/250 x 100 = 110 2 302.5 3 317.6 4 381.2