Measuring inflation: the CPI and index numbers

Inflation, deflation and disinflation

• Inflation: a sustained increase in the general price level (the rate is positive).
• Deflation: a sustained fall in the general price level (the rate is negative).
• Disinflation: a fall in the rate of inflation that stays positive, for example from 5% to 3%. Prices are still rising, just more slowly.

Index numbers

An index sets the base year equal to 100.

Index = (value in year / value in base year) x 100.

The percentage change between two index values = (new - old) / old x 100. A rise from 120 to 126 is a 5% rise, not 6%: a change of 6 index points is not the same as 6%. Similarly, a rise in inflation from 2% to 3% is a 1 percentage point rise.

Building the CPI

1. A household expenditure survey finds what households spend their money on.

2. A basket of several hundred representative goods and services is chosen.

3. Each category gets a weight equal to its share of spending (often out of 1000).

4. Prices are collected each month from many outlets and regions.

5. Each category's price index is multiplied by its weight; the total is divided by the sum of the weights.

The CPI inflation rate is the percentage change in the index over 12 months.

A simplified basket

Limitations and the PPI

Limitations of the CPI: the basket and weights are for an average household, so it does not fit the elderly, the poor or the rich; quality improvements mean some price rises are really better products; new goods take time to be included; consumers switch to cheaper substitutes; and the sample of prices is limited.

The producer price index (PPI) measures prices of inputs (raw materials) and outputs at the factory gate. Rising input costs tend to be passed on to consumers later, so the PPI can signal future CPI inflation.

Worked example

Use the simplified basket in the table (base year = 100 for every category). Find the CPI and the inflation rate.

1. 180 x 106 + 320 x 103 + 150 x 112 + 350 x 101 = 104190
2. Divide by the total weight 1000: CPI = 104.19
3. Inflation = (104.19 - 100) / 100 x 100 = 4.19%

Answer: CPI = 104.19, so inflation is 4.19%

Check yourself

1. A basket has two categories: food (weight 400, price index 110) and non-food (weight 600, price index 105). Base year = 100. Find the CPI.
   Show answer

   107. (400 x 110 + 600 x 105) / 1000 = (44,000 + 63,000) / 1000 = 107.

2. The CPI rises from 120 to 126. Find the rate of inflation in %.
   Show answer

   5 %. (126 - 120) / 120 x 100 = 5%.

3. Average house prices were $160,000 in the base year and $184,000 this year. Find the house price index this year.
   Show answer

   115. 184,000 / 160,000 x 100 = 115.

4. A price index is 140 in 2020 and 154 in 2024 (base 2015 = 100). Rebase to 2020 = 100: find the 2024 value.
   Show answer

   110. 154 / 140 x 100 = 110.

5. Inflation falls from 6% to 2%. This is
   • deflation
   • reflation
   • stagflation
   • disinflation
   Show answer

   disinflation. The rate of inflation falls but remains positive, so prices are still rising more slowly.

6. Why might a sharp rise in the producer price index be a warning to a central bank?
   • It shows consumers are spending more
   • Higher input costs are likely to be passed on as higher consumer prices
   • It means the CPI basket is out of date
   • It shows exports are falling
   Show answer

   Higher input costs are likely to be passed on as higher consumer prices. The PPI measures costs early in the supply chain, so it can lead CPI inflation.

7. Which is a limitation of the CPI as a measure of the cost of living for a pensioner?
   • It is calculated once every five years
   • It excludes food
   • It only measures producer prices
   • The weights reflect the spending of an average household, not a pensioner's
   Show answer

   The weights reflect the spending of an average household, not a pensioner's. Pensioners spend larger shares on items such as heating and food, so their inflation rate may differ.

8. Inflation rises from 2.5% to 4.0%. By how many percentage points has it risen?
   Show answer

   1.5 percentage points. 4.0 - 2.5 = 1.5 percentage points (a 60% rise in the rate).

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2 (June 2018)
• Pearson Edexcel IAL Economics WEC12 Unit 2 mark scheme, January 2025

Last updated 8 November 2026. Spotted a mistake? Tell us.