Inflation has been in the news for the past year or so and that is unlikely to change anytime soon. It’s always a factor in our lives but it’s only when inflation is particularly high or low, that it makes the headlines.
There are two main measures of inflation, CPI and RPI.
You may have heard about them on the news, but do you know what they are? Do you know how they measure inflation?
Read on and you soon will!
How inflation is measured
Inflation is the rate at which prices rise over time. The price ‘inflates’ or gets bigger and needs to be measured to government can keep some kind of control over the economy.
Every month, the Office for National Statistics (ONS) measures the prices of 743 everyday items and compares them over time to calculate the rate of inflation.
The faster the prices rise, the higher the rate of inflation.
So where do CPI and RPI come in?
CPI vs RPI – What’s the difference?
CPI and RPI both measures of how prices are changing over time, but they’re a bit different in how they’re calculated and what they cover.
CPI stands for Consumer Price Index, and RPI stands for Retail Price Index.
Both are used to track inflation, which is basically the rate at which the general level of prices for goods and services rises, leading to a decrease in purchasing power.
The main difference between the two comes down to what they include and how they’re calculated.
Let’s start with CPI.
The Consumer Price Index focuses on a “basket” of goods and services that represent the typical spending habits of households.
This includes things like food, housing, transportation, and so on.
The CPI is considered a more accurate measure of inflation because it considers changes in consumer behaviour, like when people switch to cheaper alternatives if prices rise.
Then we have RPI, the Retail Price Index.
RPI also considers a basket of goods, but includes a broader range of items, such as mortgage interest payments and council tax.
The RPI has been criticized for not being as accurate as the CPI because it doesn’t account for changing spending habits.
For example, if the price of a particular item goes up and people start buying less of it, the RPI doesn’t fully adjust for this change in behaviour, which the CPI does.
Here’s a simple example to help clarify things.
Let’s say the price of avocados goes up significantly. With the CPI, if people start buying fewer avocados and opting for cheaper fruits, this change in behaviour would be factored in, and the overall impact on inflation would be less pronounced.
However, the RPI might not capture this shift as accurately.
Another difference is how they’re used.
The government uses the CPI to set targets for inflation and make decisions about things like interest rates.
RPI is often used in things like pension calculations and other financial contracts.
In recent years, there has been a move towards using CPI as the main measure of inflation.
So, when you hear discussions about inflation in the UK, you’ll most likely encounter CPI more often because of its more modern and accurate approach.
There you have it! CPI and RPI are both ways to measure how prices are changing, but CPI is generally considered more accurate and relevant due to its focus on changing consumer behaviour.
