2.1.2: Inflation

• Inflation: General increase of prices in the economy which erodes the purchasing power of money. Low inflation is generally considered better than high inflation
• Deflation is a fall in prices and indicates a slowdown in growth rate of the economy
• Disinflation: Reduction in inflation rate, but prices are still rising
• CPI: A basket of goods which are weighted based on consumption to work out the inflation rate
• Limitations of CPI

  Does not include housing

  Different households spend different amounts

  Difficult to compare with historical data
• RPI: Similar to CPI, but includes housing and excludes top 4% of income earners and low income pensioners
• Demand Pull Inflation: Where demand exceeds supply, so firms must increase price to cut off excess demand
• Cost push inflation: Where firms' cost of production increases, so they increase price to maintain profit
• Growth of money supply: Where there is more money in the economy but no increase in the quantity of goods and services, so prices must increase to cut off excess demand