Inflation - What Does It Mean?

Inflation is a word we often hear on the news but what does it mean?

It is one of the most important functions of economics yet many people, including adults, don't understand what it means.

Inflation is defined as the rate of change in the cost of goods and services.

We can use a weekly shopping basket to demonstrate inflation.

Clare does all of her shopping online with one of the leading supermarkets.  As Clare uses the same shopping list each week the price should always be roughly the same, around £100.

Over the next year, Clare notices the price has gone up to £105 each week.

 

This £5 increase over a year is spread across each of the products in Clare's shopping basket.  Can you see the cost of each product has increased by an average of 5%?

This demonstration is a simple illustration of the Consumer Price Index (CPI) which uses hundreds of common items (bread, beer, clothing, tickets, etc...) to measure the rate of inflation.

Why is Inflation important?

The rate of inflation influences how the Bank of England sets the Interest Rate.

High Inflation (> 2%) = high Interest Rates
Low Inflation (< 2%) = low Interest Rates

These Interest Rate changes effect everything from bank accounts, mortgages, benefits and pensions.