Cambridge IGCSE Economics: Inflation and deflation (0455) – Revision Notes

These notes condense section 4.8, Inflation and deflation, of the Cambridge IGCSE Economics syllabus for examination in 2026. The course is not tiered. For full explanations and worked examples, read the study guide, then test yourself with the practice questions. The course hub, the checklist and the free diagnostics show where to go next. All figures are invented for illustration.

4.8.1 Definitions

Term	Meaning
Inflation	The general price level keeps rising over time
Deflation	The general price level keeps falling over time
Rate of inflation	How fast the price level changes, as a percentage, normally per year
Disinflation	Prices still rising, but more slowly (the rate falls but stays positive)
Price index	Prices compared with a base year set at 100
Real value	A money value adjusted for price changes
Nominal value	A money value not adjusted for price changes

4.8.2 Measuring with the CPI

The Consumer Prices Index (CPI) follows a basket of items households buy. Each group in the basket carries a weight, matching its share of typical spending.

Skill	Formula
Single price index	Current price ÷ base-year price × 100
Weighted CPI	Total of (weight × group index) ÷ total of weights
Rate of inflation	Change in CPI ÷ old CPI × 100
Real wage index	Money wage ÷ CPI × 100
Real interest rate (approx.)	Nominal interest rate − inflation rate

Method in steps: weighted CPI

1. Put each weight and group index in a table.
2. Multiply weight by index for each row.
3. Add up the products.
4. Divide that sum by the total weight.
5. Write the meaning: 107 means prices are 7% above the base year.

Reminder: weights 40 and 60, indices 104 and 109. (40 × 104 + 60 × 109) ÷ 100 = (4,160 + 6,540) ÷ 100 = 107.0.

Method in steps: rate of inflation

1. Subtract old CPI from new CPI.
2. Divide the result by the old CPI.
3. Multiply that by 100.
4. Positive means inflation. Negative means deflation.

Reminders: 150 to 153 gives 3 ÷ 150 × 100 = 2.0%. 125 to 120 gives −5 ÷ 125 × 100 = −4.0% (deflation).

A single item: a bag of rice costs 40 in the base year and 43.20 now. Index = 43.20 ÷ 40 × 100 = 108.0.

Limits of the CPI

• It measures an average household, so individual experience differs.
• The basket and weights need regular updating.
• It may not capture quality improvements.

4.8.3 Causes

	Demand-pull inflation	Cost-push inflation
Starting point	Total demand grows faster than output can	Costs of production rise
Typical causes	Cheaper borrowing, lower taxes, extra public spending, optimism, overseas orders	Higher wages, dearer raw materials or energy, indirect taxes, import prices
Output	Rises, if there is spare capacity	Tends to fall
Jobs	Joblessness tends to fall	Joblessness tends to rise

Chain for demand-pull: spending rises, orders increase and warehouses empty. Firms close to full capacity cannot expand output, so they charge more and offer higher pay to attract staff; the general price level climbs.

Chain for cost-push: input costs rise, so average cost rises. Firms raise prices to protect profit, so the price level rises.

	Demand-side deflation	Supply-side deflation
Starting point	Weak total demand	Falling costs or rising productive capacity
Typical causes	High interest rates, higher taxes, cuts in government spending, low confidence, falling exports	Cheaper raw materials or energy, new technology, higher productivity, cheaper imports
Output	Falls	Rises
Jobs	Unemployment tends to rise	Jobs tend to be maintained or grow
Overall effect	Usually harmful	Often welcome

Worked reminder: cost pass-through

A brick yard makes 5,000 bricks a month. Costs are clay 8,000, labour 12,000, fuel 4,000 and other 6,000, total 30,000, or 6.00 per brick. Clay rises 10%, labour 5% and fuel 25%. New costs: 8,800 + 12,600 + 5,000 + 6,000 = 32,400. Per brick = 6.48. The rise is 2,400 ÷ 30,000 = 8.0%.

Worked reminder: demand outruns output

Spending grows 6% while output can grow only 2%. Price level change ≈ 1.06 ÷ 1.02 − 1 = 3.9%.

4.8.4 Consequences

Group	Inflation	Deflation
Consumers	Buying power falls, hardest on fixed incomes	Lower prices, but purchases may be delayed
Workers	Real pay falls if pay rises slower than prices	Pay cuts or job losses as firms’ revenue falls
Savers	Lose if the interest rate is below inflation	Gain: money buys more
Lenders	Lose if the loan rate is below inflation	Gain: repayments worth more
Borrowers	Gain: debts shrink in real terms	Lose: debts harder to repay
Firms	Uncertainty, costs of changing prices, dearer inputs, weaker exports	Falling revenue, squeezed profit, delayed investment, closures
Economy	Weaker competitiveness, less saving and investment, redistribution	Weak spending, falling output, unemployment, a downward spiral

Worked reminders

• Real interest rate: a saving rate of 3.5% with inflation 2% gives a real rate of about +1.5%. With inflation 5% it gives about −1.5%.
• Real pay: prices rise 6% and pay 4%. Real pay changes by 1.04 ÷ 1.06 − 1 = about −1.9%.
• Menu costs: reprinting 25 menus at 2 each costs 50 each time prices change.
• Deflation and debt: a fixed debt takes up a larger share of income if wages fall.

Shoe leather costs: the effort households spend guarding the value of their money, for example hunting for lower prices. Menu costs: what firms pay each time they must change a price list.

4.8.5 Policies

Aim	Policy	How it works	Main limitation
Control inflation	Higher interest rates	Dearer borrowing and better saving returns reduce spending	Takes time; cuts output too
Control inflation	Lower money supply	Less money available to spend	Hard to control precisely
Control inflation	Higher taxes, lower government spending	Reduces spending	Unpopular; may raise unemployment
Control inflation	Higher exchange rate	Imports cheaper	Exports become dearer
Control inflation	Supply-side policy (education, training, investment)	Raises productivity and capacity	Slow
Control deflation	Lower interest rates, higher money supply	Cheaper borrowing encourages spending	Limit to how far rates fall; low confidence
Control deflation	Lower taxes, higher government spending	Raises spending	Bigger budget deficit; tax cut may be saved
Control deflation	Lower exchange rate	Exports cheaper, imports dearer	Imported inputs cost more

Evaluation prompts: What caused the price change? How long will the policy take? Does it conflict with another aim, such as low unemployment? Who gains and loses? What if the cause is outside the country’s control?

Must-know distinctions

• A rate that eases from 6% to 3% still means rising prices. Deflation needs a rate below zero.
• A high CPI does not mean high inflation. The CPI is a level. Inflation is its rate of change.
• Demand-pull starts with demand. Cost-push starts with costs.
• Supply-side deflation is often good. Demand-side deflation is usually harmful.
• Higher interest rates are a better answer to demand-pull than to cost-push.
• Nominal values ignore price changes. Real values allow for them.

Quick self-test

1. Define deflation.
2. Weights are 50, 30 and 20, with indices 110, 100 and 120. Calculate the CPI.
3. The CPI rises from 125.0 to 130.0. Calculate the rate of inflation.
4. The CPI falls from 200 to 194. State the rate and what it means.
5. Give two causes of demand-pull inflation.
6. State one cause of supply-side deflation.
7. A saver earns 2% when inflation is 3.5%. State the approximate real rate.
8. Who gains from unexpected inflation, a borrower or a lender?
9. Explain why a higher interest rate may fail to control cost-push inflation.
10. Give one reason why consumers might delay buying during deflation.

Answers

1. A sustained fall in the general level of prices.
2. (50 × 110 + 30 × 100 + 20 × 120) ÷ 100 = (5,500 + 3,000 + 2,400) ÷ 100 = 109.0.
3. (130.0 − 125.0) ÷ 125.0 × 100 = 4.0%.
4. (194 − 200) ÷ 200 × 100 = −3.0%: deflation of 3%.
5. Any two: lower interest rates, lower taxes, higher government spending, higher confidence, higher export demand.
6. Any one: cheaper raw materials, new technology, higher productivity, cheaper imports.
7. About −1.5% (2 − 3.5).
8. The borrower, because the debt falls in real terms.
9. Cost-push inflation comes from rising costs, not excess spending, so cutting demand lowers output and jobs but does not remove the cost pressure.
10. They expect prices to fall further and prefer to wait.

Where marks are usually lost

• Calling a slower rise in prices deflation.
• Giving the CPI as the rate of inflation, or the reverse.
• Dividing by the new CPI instead of the old one.
• Forgetting to divide by the total of the weights.
• Not stating whether the answer is inflation or deflation.
• Describing consequences for “people” instead of the named group in the question.
• Giving a policy without saying how it reaches prices.
• Evaluation that lists drawbacks without judging which matters most in the case given.
• Treating all deflation as harmful.

Official syllabus

Cambridge IGCSE Economics syllabus for examination in 2026, section 4.8, published by Cambridge University Press & Assessment.