Explain the difficulties in measuring inflation accurately [8 marks] (18 minutes)

Due to the nature of the process required for the measurement of inflation, several potential inaccuracies arise. One such inaccuracy results from the need of basket of products to be regularly and thoroughly updated. Due to advancements in manufacturing technology, improved training, discovery of new technologies, changes in consumer tastes and various other factors, both the items within the basket and their weights can quickly become outdated or inaccurate. For example, while a tube television might have been less expensive 20 years ago than a modern television, considering both to be equivalent within the price index would be a misleading measurement of inflation due to the vast differences in quality and features between the two products. Similarly, while a product such as themed Rio de Janeiro souvenirs may be very relevant, and hence, have a large weighting in 2016 due to the increased popularity caused by the Olympic games, the weighting of such products will need to be closely monitored and adjusted accordingly in following years. Thus, due to the constant changes in the consumption within an economy, both in terms of the quantities consumed of various products, and the products themselves, it becomes very easy for economists to omit relevant changes, in turn leading to poorly assembled baskets of goods and services and, as such, an inaccurate reading of inflation.

Another potential source from comes from taking a “bad” base year. If the base year is one with particularly unusual fluctuations in the inflation rate, this can cause very misleading calculations of the inflation rate. If, for example, the base year is one where the country experienced a period of hyperinflation, if the price level then begins to stabilize or fall in the following years, economists may end up wrongly concluding that the economy is experiencing wild disinflation or even deflation, when, in reality, it is simply recovering from the effects of hyperinflation, thus, once again, leading to an inaccurate measurement of inflation.