Monday, 16 March 2015 00:00

Inflation - Measuring Inflation

There are many different measures of inflation but all the main ones work in the same way. They attempt to measure changes in the cost of living for the average consumer using a weighted basket of goods.

 

The weighted basket

A notional basket of goods is created and the cost of the goods and services in the basked calculated. The cost of those products s then calculated again at regular intervals and compared with the first price. The goods in the basket are weighted according to the proportion of income consumers spend on those items. This is important as it means a change in the price of petrol is taken into account more than a change in the price of matches, which are a very small part of most people’s budget. Different measures of inflation include different items and different weightings. All indexes are updated regularly to ensure the goods they contain are still bought and used by households

Index Numbers

The price of this basket of goods is expressed as an index number, which has advantages and disadvantages:

  • Allows easy comparison with base year
  • Focuses on changes rather than absolute values

 But it

  •  Does not show the actual price of the basket
  • Only shows percentage change from the base year.

 

An index picks a base year and sets the price of the basket of goods in that year equal to 100. Every subsequent year is then compared to this base year. To calculate an index number:

Calculate Inflation Index

There are no units for an index number.

For example

Year

Price

2014

£1,300

2015

£1,400

2016

£1,450

 

If the base year is 2014 then the index number for this year will be 100.

The index number for 2015 will be

2015 Inflation Index Working

Have a go at the index for 2016. The answer is at the bottom of the page.

 

This inflation rate

To work out the inflation rate you need to calculate a percentage change. This is easy if you are comparing to the base year – just take off 100, but if you are comparing any two other years you need to use this formula

Inflation Rate Equation

So to work out the inflation in 2014:

Calculation for 2014 Inflation Rate

Have a go at inflation in 2015.

 

 

Answers:

2016 index number is

2016 Inflation Index Answer

Which gives an inflation rate of

 

2015 Inflation Rate Answer

Published in The National Economy