Inflation is the sustained rise in the general price level and is measured by calculating the percentage change in a price index. The main measures you will come across are the CPI (consumer price index) and the RPI (retail price index). They are calculated in different ways and so will give different results but both take the same approach - calculating the change in price of a weighted basket of goods.
Cost-push inflation is caused by the increase in firms' costs leading to increasing prices. It can create a wage-price spiral where workers demand increased wages, which in turn increases firms' costs, increasing prices, resulting in further wage demands. Demand-pull inflation on the other hand is caused by demand for goods outstripping supply, leading to shortages and price rises.
Each of these types of inflation can cause problems such as menu and shoe leather costs - the cost of changing price prices and searching out the best prices each time prices change. Inflation also tends to redistribute wealth from savers to borrowers as it erodes the value of debts and savings. This is particularly problematic if inflation is high and interest rates are low. Typically these costs are small if inflation is low and predictable but they can become significant with high or erratic inflation.
The solutions to inflation depend on the type of inflation. Reducing aggregate demand, for example by increasing interest rates, will help to solve demand-pull inflation but will have a limited impact on cost-push inflation, which is better tackled by policies to increase competition amongst firms or reducing trade union power which will help to prevent a wage-price spiral becoming established.
The revision video below will give you a brief overview of the inflation topic and cover all the major concepts you need for AS and A2 Economics exams
