2.4 Price Indices and Inflation
A price index like the CPI tracks the cost of a fixed market basket over time; the inflation rate is the percentage change in the index between two periods.
The consumer price index tracks the cost of a fixed market basket of goods a typical urban household buys. CPI = (cost of basket in current year ÷ cost of basket in base year) × 100, so the base year always reads 100 and a CPI of 130 means prices are 30% above base-year levels.
The inflation rate is the percentage change in the index between two periods: (new CPI − old CPI) ÷ old CPI × 100. Deflation is a falling price level (negative inflation); disinflation is inflation that is still positive but slowing, prices still rise, just more slowly.
Because the basket is fixed, the CPI tends to overstate inflation: it misses consumers substituting toward cheaper goods, new products, and quality improvements. A CPI level is not an inflation rate, the exam loves handing you index numbers and asking for the rate.
Key terms for 2.4
Practice the math
Reporting the CPI level as the inflation rate. A CPI of 130 does not mean 30% inflation this year, the inflation rate is the percentage CHANGE between two index values, e.g. from 125 to 130 it is 4%.
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