How Inflation is Measured

Follow us on LinkedIn Inflation is a topic that comes from economics but relates to several other fields as well. Its definition also comes from economics. However, its definition may differ elsewhere, while the fundamental concept is the same. Inflation is quantifiable and measurable based on several indexes. However, before understanding how to calculate it, it is critical to understand what it is.

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What is Inflation?

Inflation refers to the decrease in the purchasing power of a currency over a period of time. Similarly, it may represent the increase in the price levels of goods and services over a specific time. Due to the increase in the prices of goods or services of a country, its currency’s purchasing power decreases. There are various causes of inflation.

What are the causes of Inflation?

In economics, there are four primary factors that cause inflation. Firstly, demand-pull inflation comes due to the aggregate demand exceeding the aggregate supply of goods and services. On the other hand, cost-push inflation occurs from increases in the cost of production. The increase in the cost of production stems from the rise in prices of commodities. Inflation may also occur due to the money supply. Therefore, an increase in the money supply also gives birth to inflation. Another factor that may play a crucial role in an increase in inflation is expectations. When consumers and producers expect a persistent rise in prices in the future, it causes inflation to occur.

How is Inflation measured?

There are several methods used to measure inflation. These measurements come from observing the changes in various price indexes. Most commonly, however, the Consumer Price Index (CPI) is the most prominent index used as a proxy for inflation. The index expresses the change in the current prices of the market basket relative to the prices during the same period in the previous year. The CPI measurements may come monthly or quarterly. It uses the expenditure patterns of almost all urban resources coming from all ages. Similarly, the CPI uses 1982-84 as a base for comparison. The index during that time was 100. Therefore, an increase in the index means the price of the basket has increased by the difference in the base and current index. For example, if the inflation based on CPI is 180, then it means that there is an 80% (180 – 100) increase in the price of the market basket. However, it does not give the percentage change in inflation. The following formula helps calculate the percentage change in inflation.

Inflation = (Inflation for current period – Inflation for base period / Inflation for base period) x 100

This formula will represent the percentage change in inflation based on the index for a specific period. For example, one can calculate the change in inflation from Year 1, when the inflation was 200, to Year 5, when it was 230. Using the formula, the percentage change in inflation will be 15% [(230 – 200) / 200 x 100].

Conclusion

Inflation refers to the increase in the prices of goods and services. The hike further causes the purchasing power of a currency to decrease. Several causes may cause inflation. The measurement of inflation comes from various indexes. For that purpose, the most common index is the Consumer Price Index (CPI).