The aim is to measure how consumers’ purchasing power is affected by rising prices. There are three main steps to measuring inflation
- Give a weighting to the importance of different goods to the typical basket of goods.
- Measure the change in price
- Convert into the index – multiplying the weight by the price change.
- Household expenditure survey – This seeks to measure what people spend their money on. From finding out typical consumption patterns, the statistics body can create a typical basket of goods.
- In the UK the top 12 categories of goods and services are
- This basket of goods gives a relative importance to each different item. E.g. if gas and electricity prices increase by 10% this would have a higher weighting than an increase in the price of avocados.
- The basket of goods is updated each year to take into account changes in expenditure
- Every month changes in the prices of goods and services are monitored and combined into a single figure with using the weights in the basket of gods.
- To calculate inflation we multiply the weighting of the good x the new price index and then combine all the new price changes
Example of calculating inflation from weights and price changes
- Therefore inflation is 25%
In the above example, we assume coal has a weighting of 40% and bread accounts for 10%.
Other factors in measuring inflation
- Seasonally adjusted. The inflation index can adjust for seasonal changes in price e.g. high prices in December – sales in Jan.
- Adjusting for quality. A complication in measuring inflation is how to do we measure the price of mobile phones if – every year, the quality of the phone increases. If the iPhone increases in price – is this inflation or is it because it has more features. Inflation measures take into account the type of good may be changing so every price increase may not be inflationary but changing good.
Difficulties in measuring inflation
- Which measure to use? Some measures CPIH include housing costs (mortgage repayments). Some exclude. If interest rates rise, then it will increase the cost of living for people with mortgages – but not for those renting. Different measures of inflation.
- The quality and types of goods are constantly changing so it is hard to keep up to date and consistent price checks.