Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Working Out Inflation: Looking into the Average Shopping Basket

Economists always express inflation as a percentage change over a year. So if inflation in the UK is currently 2 per cent, on average prices are now 2 per cent higher than this time last year. Sounds simple enough: the tricky bit is calculating by how much prices have risen. In the UK, this job falls to the Office for National Statistics (ONS).

In this section, we describe the process for calculating inflation and some factors that complicate it. We also discuss three different measures for inflation, detailing each one’s strengths and weaknesses.

Compiling a basket of products and services


The main measure of inflation in the UK (and also many other countries, including the US) is calculated using the Consumer Price Index (CPI; see the later section ‘Assessing different measures’ for more details). The CPI measures the average price of goods and services that consumers bought (as opposed to firms or the government).

The rate of inflation affects so many things, such as state benefits, pensions, contracts, tax bands and salaries, that calculating it accurately is vitally important. The first task is to create a large ‘representative basket’ of goods and services on which people spend their money. This basket contains all sorts of items: chocolate bars (yum!), bleach (not so yummy), cinema tickets (what fun!), holidays (can we come?) and so on. Basically, the basket should include anything and everything that consumers typically spend their money on.

When the total cost of the basket increases, this change is reflected as an increase in the CPI. So, if the cost of purchasing the basket’s contents goes up by 5 per cent, the CPI also increases by 5 per cent.

Of course, consumers’ tastes change over time, so the composition of the basket also changes – every year it’s updated to reflect the current spending patterns of the population. Equally important is the fact that some items make up a larger proportion of expenditure than others. So, for example, energy bills represent a large fraction of expenditure for most people, while postage stamps don’t. In order to account for this, different goods are given different weights, so an increase in energy prices has a bigger impact on the CPI than an increase in the price of stamps.

When statisticians have decided on the basket and the weights, someone needs to collect data about prices. This job is a huge undertaking: every month around 100,000 prices for over 500 goods and services are recorded. Much of this data is now compiled electronically, but a substantial amount is still collected by an army of price collectors who physically visit local shops to record the prices!