Introduction to Inflation

Inflation is a central concept in economics. It reflects the rise in the general price level of goods and services in an economy over time. For A-Level Economics students, understanding inflation is critical. It directly affects everything from purchasing power to government and central bank policy. Inflation is not inherently bad. However, when it rises too quickly, it creates economic instability. This situation harms both consumers and businesses. Conversely, inflation that is too low can signal a stagnant economy.

In this blog, we will explore the different types of inflation. We will explain how inflation is measured in the UK. This explanation involves tools like the Consumer Prices Index (CPI) and the Retail Prices Index (RPI). Additionally, we will discuss the causes and effects of inflation. We will also examine the limitations of CPI. We will discuss how inflation impacts various groups, such as consumers, firms, workers and the government.

Mastering Theme 2: UK Economy, Policies & Performance Guide

FAQs

What is the difference between CPI and RPI?

CPI excludes housing costs, while RPI includes them. Additionally, RPI is often criticised for its outdated methodology.

What causes demand-pull inflation?

Demand-pull inflation happens when consumer demand for goods and services exceeds supply, driving up prices. This leads to a rightward shift in the aggregate demand curve, leading to a higher price level and increased output.

What causes cost-push inflation?

Cost-push inflation happens when aggregate supply is restricted. This leads to a leftward shift in the aggregate supply curve, leading to a higher price level and reduced output.

How does inflation impact workers?

Inflation can erode real wages if price increases outpace wage growth, reducing workers’ purchasing power.

What is the Bank of England’s role in controlling inflation?

The Bank of England controls inflation by setting interest rates and, in extreme cases, engaging in quantitative easing.

Can inflation be entirely avoided?

No, moderate inflation is considered a normal part of a growing economy. However, excessive inflation can lead to economic instability.