Inflation - Explanation

Inflation is usually defined as a sustained increase in the general price level. We measure it as the annual percentage increase in prices. It can be measured as a monthly change, but the most often quoted figure is the annual change. The prices usually measured are retail prices.

The index that measures inflation is called the retail price index. Inflation is changes in the RPI. There are other indices that measure different types of price changes. There are the wholesale price index, the pensioner price index and the tax and price index among others.

The RPI is measured by taking a large number of prices, working out how much each price has changed and then weighting the price changes according to their importance. This is because some price changes have a much bigger impact on people than others. For example, a 5% increase in food prices is likely to affect people much more than a 100% increase in the price of matches (unless they are pyromaniacs!). Food therefore gets a much bigger weighting than matches, and changes in the price of food will have a bigger effect on the RPI.

Over the last two decades, inflation has varied considerably. It tends to follow a cyclical pattern: increasing at boom periods of the trade cycle, and falling when economic growth slows down. The figure below shows this cyclical pattern clearly.

Inflation 1979-1997

Why not also have a look at the relevant theories about inflation, or have a go at worksheets about it?