Theme 2 - Topic Questions (Inflation)

Question 1

Define inflation

Answer 1

An increase in the general price level in an economy.

Question 2

What is meant by CPI inflation?

Answer 2

Consumer Price Index is an international for calculating inflation, and is the rate that the Bank of England use when setting their inflation target.

Question 3

Define ‘base year’

Answer 3

The year all values are compared to. The index number is always 100.

Question 4

Define ‘weight’

Answer 4

The relative importance of and item. The more important the item, the greater the weight. This means that a change in the price of this good will have more of an impact on the rate of inflation than an item with a smaller weight.

Question 5

If inflation is 2% in 2013 and 1% in 2014 what has happened to the price level?

Answer 5

Disinflation - price level is still increasing but at a slower rate

Question 6

Explain at least 4 steps in the calculation of CPI inflation

Answer 6

• An annual Household Expenditure Survey is used to identify a typical basket of goods that are consumed - around 650 goods are in this basket.
• Each item in the basket is given a weight depending on how much income is spent on average on this item.
• A monthly price survey takes place to check the prices of the goods in the basket at different retailers.
• Taking into account the weights of each item an index is created which tracks the price level of all goods in the basket and can be compared to the base year, where the index number is 100.

Question 7

Why do the items in the ‘basket’ of goods have to be updated every year?

Answer 7

To reflect the changing composition of consumption, the basket must reflect contemporary consumption patterns. For example, many commodities available today were not even invented 30 years ago.

Question 8

Define ‘weighted index’

Answer 8

A composite index where the value at a point in time is calculated by applying weights to the different items in the index e.g. The HDI is a weighted index and so is CPI inflation

Question 9

Why is CPI rather than RPI used as the main measure of inflation in the UK?

Answer 9

Because this is the international standard for calculating inflation and it means that inflation comparisons can be made against other countries

Question 10

What is meant by deflation?

Answer 10

A fall in the general price level, or negative inflation

Question 11

What is meant by disinflation?

Answer 11

A fall is the rate of inflation e.g. from 3% to 2.3%