Inflation shows the increase in the general level of prices in an economy.
This phenomenon is explained through the following reasoning: If the number of goods in an economy is the same and, nevertheless, the money in circulation increases, then prices will rise, generating inflation.
Conversely, if the number of goods in an economy increases and the quantity of money remains constant, then prices will fall, causing deflation.
Regarding its implications, inflation implies a loss in the purchasing power of money, while deflation implies the opposite, that is, a gain in the purchasing power of money.
Inflation is calculated through price indices. There are two main ways to calculate it: Considering all goods and services (GDP price index) or considering consumer goods and services (Consumer Price Index, CPI):
To carry out the calculation of a CPI, a certain basket of goods and services that is considered representative of the consumption carried out in a country is used.
Below is an example to illustrate the calculation of the CPI:
- Selection of the basket of goods and services: A, B and C.
- Allocation of a weight to each category: 40%, 50%, 10%, respectively.
- Measurement of prices on the base date (December of year X-4): Price of product A, 20 c.u.; price of product B, 10 c.u.; price of product C, 50 c.u.
- Calculation of the index value on the base date (December of year X-4):
Weighted average:
20 x 40% + 10 x 50% + 50 x 10% = 18 → 18 = 100
18 is taken as reference, which is assigned an index number of 100. - Price measurement in December of year X: Price of product A, 30 c.u.; price of product B, 20 c.u.; price of product C, 60 c.u.
- Calculation of the index value in December of year X:
30 x 40% + 20 x 50% + 60 x 10% = 28 - Calculation of the CPI:
As can be seen from the foregoing, the CPI would have increased by 55.56% in the period between December of year X-4 and December of year X.
The above is shown in the following table:
| Year X-4 | Year X | ||||
| Goods | Weight in consumption “basket” | Price (c.u.) | Price x Weight | Price (c.u.) | Price x Weight |
| A | 40% | 20 | 8 | 30 | 12 |
| B | 50% | 10 | 5 | 20 | 10 |
| C | 10% | 50 | 5 | 60 | 6 |
| 100% | Weighted average price (c.u.) | 18 | Weighted average price (c.u.) | 28 | |
