Measuring Inflation - What you need to know at AS (Revision)

Inflation is defined as "a general increase in prices, and fall in the purchasing value of money overtime". 

How inflation works can be shown through a trip to the supermarket. I head to Sainsbury's and purchase a trolley full of a range of goods for £100. I then return to the supermarket a year later and purchase the same items, this time coming to a total of £105. I have experienced the effects of a 5% inflation rate. If I am to purchase these goods I will have to spend an extra £5 to what I did last year or I will need to remove an item from my trolley (shoplifting is against the law, no kleptomaniacs please). Inflation thus leads to higher prices and lower purchasing power. It tends to be a monetary phenomenon caused by a country printing more money than is justified by the country's wealth.

There are two main methods used to measure inflation in the UK. One being the Consumer Price Index (CPI) and the other being the Retail Price Index (RPI). The consumer price index (CPI) is a weighted index. The results from a Family Expenditure Survey are used to find out what people spend their money on. It measures a monthly change in the prices of over 600 different goods and services. These products have weights attached to them. The weight reflects the proportion spent on the different items. For example, if 15% of  consumer expenditure is on food then this will be given a weight of 15/100. 

The expenditure weights are held constant for a year. They are then reviewed and changed depending on a change in the households spending patterns. Then, throughout the year government employees visit a range of outlets throughout the country gathering price quotations for the 600 different goods and services. This is completed each month. Ultimately, the weights are multiplied by the new price index for each category in order to find a change in the total price level. 

The RPI uses the same basket of goods and services that the CPI uses but also includes housing costs (house prices and mortgage and council tax payments) that are excluded from the CPI. The RPI also uses the arithmetic mean between the old and new price whilst CPI uses the geometric mean. The end result of this is that the RPI always gives a larger figure for inflation than CPI. 

So what ones better? 

• CPI is regarded to be more accurate. It's maths is truer and reflects to the inflation that a lot more people experience.
• The RPI does not meet international standards. It doesn't match what other countries do.
• The CPI excludes all housing costs including mortgages, interest payments and council tax. It also excludes the road fund licence and TV licence.
• Both do not respond to changes in quality. Although the price of a good or service may rise, this may be accompanied by an improvement in quality. In this respect, both measures may over-estimate inflation. 
• Both do not take into account the prices of second hand goods. 

All in all, it is difficult to measure inflation within an economy. There are many factors that cannot be taken into account but may have a large effect on the rise or fall in levels of inflation. This therefore makes it hard to put a definitive value on the exact rate of inflation at a given time.

YOUR IDEAS:

At this point in time, the UK inflation rate is 1.9%. This is lower than the Bank of England's target of 2%. Is this good or bad for our economy? Tell us your thoughts!