Inflation is a sustained increase in the average price level of an economy.

  • the rate of inflation is measured by the annual percentage change in the level of prices as measured by the consumer price index
  • a sustained fall in the general price level is called deflation—in this situation the rate of inflation becomes negative

Consumer Price Index (CPI)

  • the consumer price index is the mean measure of inflation for the UK
  • the government has set the Bank of England a target for inflation (using the CPI) of 2%
  • the aim of this target is to achieve a sustained period of low and stable inflation
  • low inflation is also known as price stability

Two main causes of inflation

Demand pull

  • when there is excess demand

Cost push

  • when costs rise

Inflationary case study:

Main causes of demand pull inflation

  • Very fast growth of demand for credit/borrowing
  • High levels of consumer spending


  • A period when general price levels fall
  • Normally associated with a significant reduction in economic activity (depression/slump)
  • Can also occur if the economy is rapidly building its productive potential

Economic & Business costs of deflation

  • Consumers postpone spending if they believe prices will go lower
  • The real value of debt increases and makes it harder to pay debt off
  • Falling asset prices (such as housing)
  • Business profit margins fall due to lower selling prices

Some inflation is good for business

Effect of inflation on revenue

  • The price elasticity of demand is an important factor in how inflation will impact revenue
  • If the product is price elastic, then revenue is likely to fall during inflation
  • If the product is price inelastic, then revenue will not change much during inflation
  • Price elasticity of demand refers to the responsiveness of demand to changes in price

Inflation and business costs

  • A rise in general inflation:
    • Sales revenue should rise
    • But workers are more likely to demand higher pay to compensate for consumer price inflation
    • Labour intensive industries at more risk
  • Input cost inflation
    • Cost-push inflation will vary from industry to industry
    • Firms that need to buy significant commodity raw materials may find profit margins squeezed if they cannot pass on increased costs to customers