Inflation

Edexcel IGCSE Economics (4EC1) · Section C: Government and the Economy

Specification points

• Inflation and deflation, and how inflation is measured.
• The causes of inflation.
• The consequences of inflation.

Definitions

• Inflation is a sustained rise in the general price level, so money buys less.
• Deflation is a sustained fall in the general price level.

Inflation is measured by the Consumer Price Index (CPI), which tracks the price of a basket of goods a typical household buys.

Causes of inflation

• Demand-pull inflation — total demand grows faster than supply, pulling prices up.
• Cost-push inflation — rising costs (wages, raw materials, energy) push firms' prices up.

Demand-pull = "too much demand"; cost-push = "rising costs".

Key definitions

Consequences of inflation

• Falling real incomes — if wages rise slower than prices.
• Savings lose value over time.
• Uncertainty makes firms and households cautious.
• Loss of competitiveness — if prices rise faster than abroad, exports fall.

Deflation can also harm the economy, as consumers delay spending expecting lower prices, cutting demand and jobs.

Worked example

Rising world energy prices push up firms' costs across the economy, causing cost-push inflation. Workers on fixed wages find their real income falls, savers lose out, and exports become less competitive. The central bank may raise interest rates to bring inflation down.

Common exam mistakes

• Confusing demand-pull and cost-push causes.
• Confusing deflation (falling prices) with disinflation (slower price rises).

Exam technique

Identify the cause (demand-pull or cost-push), explain the consequences for consumers, savers and firms, and suggest a policy response.

Quick revision

• Inflation = rising prices; measured by CPI.
• Causes: demand-pull and cost-push.
• Costs: lower real income, lost savings, uncertainty, weaker exports.