Unit 6.1 Uses of the Consumer Price Index
1. As an economic indicator of price inflation
A consumer or retail price index is a widely used measure of price inflation and
therefore a measure of changes in the cost of living.
2. As a price deflator
Rising prices reduce the purchasing power of wages, profits, pensions and savings.
A price index is therefore used to take into account inflation and to calculate
changes in their real values over time.
3. For indexation
Indexation involves linking changes in certain payments, such as wages and
pensions to the rate of inflation to ensure that their real value does not change over
time.
Causes of inflation
There are generally three main causes of inflation:
1. Excessive growth in the money supply. The money supply can grow if the
government issues more notes and coins in circulation or by encouraging the
banking sector to make more loans available (more credit) or more attractive
(through lower _______________ rates). If businesses and households have
access to more money they will spend.
This is not a problem if firms are able to match the increase in spending with
an increase in _________________, but if firms cannot expand production quickly
enough you end up with the classic situation of ‘too much money chasing
too few goods’. This will force prices to rise.
2. Demand pull inflation: This is similar to the first cause of inflation. If there
is an increase in any of the components of Aggregate Demand: (C____________,
I______________, G_______________________ or Net E____________________), and firms are
not able to expand output to keep up with the higher spending then we have
a situation of demand- pull inflation.
3. Cost-push inflation is caused by rising wages and other production costs.
Firms will raise their prices to cover these additional costs. A rise in import
prices may cause an imported inflation. Import prices may rise following a
fall in the exchange rate of the importing country.