What is Inflation?
Inflation is the rate at which the general level of prices for goods and services rises, eroding purchasing power over time. It's typically measured using the Consumer Price Index (CPI).
The inflation rate is calculated as the percentage change in the Consumer Price Index (CPI) between two periods: Inflation Rate = ((CPI_new − CPI_old) / CPI_old) × 100.
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Step-by-step worked examples
CPI was 220 last year and is 231 this year. Find the inflation rate.
Inflation = ((231-220)/220) × 100 = (11/220) × 100 = 5%
A basket of goods cost $500 last year and costs $515 this year. Find the inflation rate.
Inflation = ((515-500)/500) × 100 = (15/500) × 100 = 3%
If prices rise from an index of 150 to 156, what is the inflation rate?
Inflation = ((156-150)/150) × 100 = (6/150) × 100 = 4%
Flashcards
Quick quiz
Q1.CPI rises from 200 to 210. What is the inflation rate?
Q2.What index is most commonly used to measure inflation?
Q3.What does inflation do to purchasing power?
Q4.A sustained fall in the general price level is called:
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Common mistakes
Confusing inflation with a price increase for a single product. — Correct: Inflation refers to the GENERAL price level across the whole economy, not one item.
Using the wrong base period in the formula. — Correct: Always divide by CPI_old (the earlier/base period), not CPI_new.
Thinking inflation always hurts everyone equally. — Correct: Inflation hurts savers/lenders holding fixed cash, but can benefit borrowers who repay with cheaper future money.
Assuming zero inflation is always ideal. — Correct: Most central banks target a small positive inflation rate (often ~2%) to avoid deflation risks.
FAQ
What is inflation?
Inflation is a sustained increase in the general price level of goods and services in an economy over time.
What is the inflation formula?
Inflation Rate = ((CPI_new − CPI_old) / CPI_old) × 100, using the Consumer Price Index.
How do you calculate inflation?
Take the change in CPI (or a price index) between two periods, divide by the earlier CPI, and multiply by 100.
What are examples of inflation?
A basket of goods that cost $500 last year costing $515 this year reflects 3% inflation; rising grocery and rent prices over time are everyday examples.