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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