Economics explained
Category:
Inflation and deflation
Measuring Inflation
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Measurement of inflation
Inflation erodes the real value of money. In order to measure changes in the real value of money as a single figure, we need to group all goods and services into a single price index.
Consumer price index
A consumer price index is based on a chosen 'basket' of items which consumers purchase. A weighting is decided for each item according to the average spending on the item by consumers
Stages in constructing consumer price indices.
Selecting a base year:
This is usually a relatively standard year in which nothing unusual has occurred. It is given a value of 100. The base year is changed on a regular basis.
Carrying out a survey to find people’s spending patterns:
A sample of the population’s households are asked to keep a record of what they buy. The products purchased are placed into categories such as food and clothing and footwear.
Attaching weights to the different categories:
Weights are based on the proportion of total expenditure spent on the different categories. For instance, if on average households spend $500 of their total expenditure of $2,000 on food, the category will be given a weight of ¼ or 25%.
Finding out price changes:
Prices in a range of retail outlets and from a number of other sources such as gas companies and train companies are recorded.
Multiplying weights by price changes:
The total will give the change in the consumer price index but it can go much higher.