Cambridge IGCSE Economics 0455
Syllabus points
- Define inflation and deflation and how they are measured.
- Explain the causes of inflation.
- Explain the consequences of inflation and deflation.
Definitions
- Inflation is a sustained rise in the general price level, so money buys less over time.
- Deflation is a sustained fall in the general price level.
- Disinflation is a fall in the *rate* of inflation (prices still rise, but more slowly).
Inflation is measured by the Consumer Price Index (CPI), which tracks the price of a "basket" of goods a typical household buys.
Key definitions
| Term | Definition |
|---|---|
| Inflation | A sustained increase in the general price level. |
| Deflation | A sustained fall in the general price level. |
| Consumer Price Index (CPI) | A measure of the average price of a basket of household goods. |
Causes of inflation
- Demand-pull inflation — total demand grows faster than supply, pulling prices up (often in a boom).
- Cost-push inflation — rising costs (wages, raw materials, energy) push firms' prices up.
Demand-pull = "too much demand"; cost-push = "rising costs".
Consequences of inflation
- Falling real incomes — if wages rise slower than prices, people can buy less.
- Savings lose value — money saved is worth less over time.
- Menu and uncertainty costs — firms must keep changing prices; planning is harder.
- Loss of competitiveness — if prices rise faster than abroad, exports fall.
Consequences of deflation
Deflation sounds good but can be harmful: consumers delay spending (expecting cheaper prices later), so demand falls, firms cut output and unemployment rises — a downward spiral.
Worked example
Rapidly rising oil prices raise firms' transport and energy costs across the economy, so they raise prices — 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 back down.
Common exam mistakes
- Confusing deflation (falling prices) with disinflation (slower price rises).
- Mixing up demand-pull and cost-push causes.
Exam technique
Identify the cause (demand-pull or cost-push) from the context, then explain consequences for consumers, savers, firms and trade, and a suitable policy response.
Quick revision
- Inflation = rising prices; deflation = falling prices; measured by CPI.
- Causes: demand-pull and cost-push.
- Costs: lower real income, lost savings, uncertainty, weaker exports.