Measurement of Inflation.

Authors Avatar

Measurement of Inflation

Definition of Inflation

Inflation refers to the continual increase in prices. The value or purchasing power of money refers to the amount of goods or services one pound can buy. Inflation means the value of money is falling because prices keep rising.

Calculating the Retail Price Index

The retail price index (RPI) is a monthly survey carried out by the government which measures price changes. The following procedure is used:

  • A basket of goods and services consumed by the average family is listed. For example, food, clothing and transport are included in the basket.
  • The price of items in the basket in the base (first) year is noted.
  • Each item in the basket is given a number value (weighted) to reflect its importance to the average family. For example, food has a higher weighting than transport.
  • The price of goods in the basket is recorded every month compared with base year as a percentage (price relative) using the equation:

    Price relative = Current price/Base price x 100
  • The price relative of each item is then multiplied by its weighting.
  • The new RPI is found using the equation:

    RPI = Total weightings x Price relative/Total weightings

    The value of the RPI in the base year is always 100. After twelve months the price of good items in the basket may have risen by 25 per cent and that of housing by 20 per cent while the cost of transport is unchanged. Table 16.1 shows how the RPI for year two might then be calculated.

    The RPI = Total weightings x Price relative/Total weightings = 12 100/100 = 121
Join now!

Table 16.1 Calculation of the retail price index

The rate of inflation is the percentage change in the RPI over the last twelve months and is calculated using the equation:

Rate of inflation = (Current RPI - Last RPI)/Last RPI x 100

At the beginning of year two the rate of inflation is:

(121 - 100)/100 x 100 = 21 per cent

See the  of Biz/ed for a worksheet on calculating and interpreting index numbers.

Problems in Using the Retail Price Index

  • Which items should be included in or excluded from the basket of goods?
  • Different families have different tastes ...

This is a preview of the whole essay