Measuring inflation using a price index

The UK's inflation rate fell from a peak of 11.1% in October 2022 to 2.2% in July 2024. This period of falling inflation or disinflation can partly be attributed to contractionary monetary policy, with the Bank of England raising interest rates at the end of 2021 and falling energy prices as the price of oil and gas decreased from their peak in 2022.

An important part of understanding the UK’s rate of inflation is to examine how the rate of inflation is calculated. In the UK, the Office for National Statistics collects around 180,000 monthly prices for about 700 goods and services. Each item in the index is grouped according to a product category, shown in the table below. The product categories are weighted based on the average consumer expenditure on goods in each product category. These weights are shown in the table. For example, housing, water, electricity, gas and other fuels have a weighting of 303/1000, which is the highest weighting in the CPI because it accounts for the highest proportion of consumer expenditure.

Goods and services move in and out of the index over time because of changing consumer tastes and preferences. For example, vinyl records, gluten-free bread and air fryers have come into the index with hand gels, pork chops and sofa beds dropping out. Air fryers are the new ‘must have’ for UK consumers in the kitchen, and people are not buying as much hand gel as households do not have the hygiene issues associated with the pandemic as much in their minds.

The final inflation number is calculated by multiplying the price index for each category of goods and services by its weighting and then summing this value for each product category to give the total weighted index number. The percentage change in this number from the same month in the previous year is the UK’s annual inflation rate.

A country’s inflation rate is one of its key economic indicators, and it is important because firms, households and governments use it to make decisions such as setting prices on goods and services, making wage demands and deciding on state benefit changes. However, it is not a perfect piece of data; an average household and different households will all have their own inflation rate. For example, pensioners buy different baskets of goods compared to university students, and their inflation rates will be different because of this.

Source: Consumer price inflation from the Office for National Statistics (https://www.ons.gov.uk/economy/inflationandpriceindices/articles/ukconsumerpriceinflationbasketofgoodsandservices/2024)

Some possible questions to discuss with a class

1. Research some of the goods and services entering and leaving your country's CPI.

2. Why do some goods and services enter and leave a country's CPI?

3. Why do goods and services have to be weighted in a country's CPI?

4. Discuss the problems of using a CPI to measure inflation.