Inflation, deflation and purchasing power
| English | 中文 | Pinyin |
|---|---|---|
| deflation/diːˈfleɪʃn/ | 通货紧缩 | tōng huò jǐn suō |
| consumer price index/kənˈsuːmə praɪs ˈɪndeks/ | 消费者价格指数 | xiāo fèi zhě jià gé zhǐ shù |
A decision you can investigate
- A family’s shopping basket costs more, while a café replaces its printed menus.
- The consequences of inflation include real purchasing power and costs of adjusting to price changes.
Build the explanation
- Inflation is a sustained rise in the general price level; deflation 通货紧缩 is a sustained fall. CPI tracks the cost of a weighted consumer basket. Inflation rate = (new CPI−old CPI)/old CPI × 100.
- Demand-pull inflation can follow spending rising faster than available output. Cost-push inflation can follow higher energy, wages or imported input costs. One expensive product alone does not establish general inflation.
Work through the evidence
- CPI rises from 120 to 126: inflation = 6/120 × 100 = 5%. A wage rises from 2000 to 2060, or 3%. Real wage change is approximately 3−5 = −2%; exactly, purchasing-power ratio = 1.03/1.05, a fall of about 1.90%.
- Menu costs are costs of changing prices. Shoe-leather costs are extra effort managing money balances. Uncertain future costs/prices can weaken confidence and investment; domestic prices rising faster than foreign prices can reduce export competitiveness.
CPI rises from 120 to 126. Inflation is
Divide the 6-point increase by the initial 120.
Test the limits
- Central banks may raise interest rates to restrain spending and inflation; this can reduce investment and employment. Cost-push inflation can combine higher prices with weaker output and higher unemployment.
- Borrowers and savers experience different effects, especially when rates fail to adjust. Lower inflation means prices rise more slowly; it is not deflation. CPI weights may not match every household’s basket.
Which is cost-push pressure?
Higher input costs can raise selling prices and reduce output.
Inflation can reduce export competitiveness when domestic prices rise faster than foreign prices.
Relative prices can make domestic exports less attractive, other factors unchanged.
Apply and explain your answer
- Why does a 3% wage rise fail to preserve purchasing power in this example?
- The consumer basket rises 5%, faster than the wage.
Inflation falls from 5% to 2%. What happens to the general price level?
A positive inflation rate still means rising prices.
Use the terms precisely
- consumer price index 消费者价格指数: An index of prices for a weighted basket of consumer purchases.
- deflation: A sustained fall in the general price level.
Match the terms to their meanings.
Each term describes a specific mechanism in this lesson.
CPI rises from 120 to 126: inflation = 6/120 × 100 = 5%. A wage rises from 2000 to 2060, or 3%. Real wage change is approximately 3−5 = −2%; exactly, purchasing-power ratio = 1.03/1.05, a fall of about 1.90%. Menu costs are costs of changing prices. Shoe-leather costs are extra effort managing money balances. Uncertain future costs/prices can weaken confidence and investment; domestic prices rising faster than foreign prices can reduce export competitiveness.
Central banks may raise interest rates to restrain spending and inflation; this can reduce investment and employment. Cost-push inflation can combine higher prices with weaker output and higher unemployment. Borrowers and savers experience different effects, especially when rates fail to adjust. Lower inflation means prices rise more slowly; it is not deflation. CPI weights may not match every household’s basket.
Inflation is a sustained rise in the general price level; deflation is a sustained fall. CPI tracks the cost of a weighted consumer basket. Inflation rate = (new CPI−old CPI)/old CPI × 100.