Pearson Edexcel International GCSE Economics: Inflation, deflation and the CPI (4EC1) – Revision Notes

These notes condense section 2.1.1 b), low and stable inflation, from the Pearson Edexcel International GCSE Economics (4EC1) specification, Issue 3, February 2026. It is a single-tier course and this content is examined in Paper 2. For full explanations and worked examples read the study guide, then try the practice questions. The course hub, checklist and free diagnostics show where to go next. All data are invented for illustration.

Key definitions

Term	Definition
Inflation	A sustained rise in the general level of prices
Rate of inflation	The percentage change in the price level over a period, usually a year
Deflation	A sustained fall in the general level of prices
Consumer price index (CPI)	A weighted index of the average change in prices of a basket of goods and services bought by households
Demand-pull inflation	Inflation caused by total demand growing faster than the economy can produce
Cost-push inflation	Inflation caused by rising costs of production that firms pass on in higher prices
Real wage	Wages adjusted for changes in prices, showing what the pay can buy
Menu costs	The costs to firms of changing their prices
Shoe leather costs	The time and effort spent protecting the value of money, such as searching for cheaper prices

Calculations

Skill	Formula
Weighted CPI	Sum of (weight × group index) ÷ sum of weights
Group index	Current price ÷ base price × 100
Rate of inflation	(new CPI − old CPI) ÷ old CPI × 100
Real wage index	Nominal wage ÷ CPI × 100
Approximate real interest rate	Nominal rate − rate of inflation
Interest on a loan or savings	Amount × rate ÷ 100 (for one year)

Method in steps: weighted CPI

1. Write each group’s weight and index in a table.
2. Multiply each weight by its index.
3. Add the products.
4. Divide by the total of the weights (100 if the weights are percentages).
5. State the CPI, and say what it means: 108 means prices are 8% above the base year.

Worked reminder: weights 40 and 60, indices 105 and 110. (40 × 105 + 60 × 110) ÷ 100 = (4,200 + 6,600) ÷ 100 = 108.0.

Method in steps: inflation or deflation rate

1. Subtract the old CPI from the new one.
2. Divide by the old CPI.
3. Multiply by 100.
4. A positive answer is inflation. A negative answer is deflation.

Reminders: 125 to 130 gives 5 ÷ 125 × 100 = 4.0%. 108 to 105.3 gives −2.7 ÷ 108 × 100 = −2.5% (deflation).

Causes in a table

	Demand-pull	Cost-push
Diagram	AD shifts right	AS shifts left
Typical causes	Lower interest rates, tax cuts, more government spending, confidence, export demand	Higher wages, raw material and energy prices, indirect taxes, import costs
Real output	Rises, if spare capacity	Falls
Likely effect on jobs	Unemployment tends to fall	Unemployment tends to rise

Chain for demand-pull: more spending, so stocks fall and orders rise, so firms near capacity raise prices and offer higher wages, so the general price level rises.

Chain for cost-push: higher input costs, so average costs rise, so firms raise prices to protect profit, so the general price level rises and sales may fall.

Inflation and interest rates

• Rising inflation tends to bring higher interest rates. Dearer borrowing and better rewards for saving reduce consumption and investment, so AD grows more slowly.
• Low inflation or deflation tends to bring lower interest rates, to encourage spending.
• Inflation above the savings rate means savers lose purchasing power. A negative real rate helps borrowers.

Effects of inflation: one-line chains

• Prices: purchasing power falls, and fixed-income households lose most.
• Wages: real wages fall if pay rises slower than prices. Large pay claims can raise costs further.
• Exports: if home inflation exceeds rivals’ (with the exchange rate unchanged), exports become dearer, sales fall, and imports look cheaper.
• Unemployment: lower sales and higher interest rates can lead firms to cut jobs. Demand-pull inflation often accompanies falling unemployment first.
• Menu costs: relabelling, reprinting and reprogramming each time prices change.
• Shoe leather costs: time and effort spent searching for prices or moving money.
• Uncertainty: firms cannot plan costs and revenue, and long contracts become risky.
• Confidence: households and firms cut spending and delay decisions.
• Investment: higher interest rates and uncertain returns delay investment and reduce future capacity.

Must-know distinctions

• Inflation falling from 5% to 2% is still inflation. Deflation needs the CPI itself to fall.
• A high CPI is not high inflation. The CPI is a level. Inflation is the rate of change.
• Nominal means in money terms. Real means adjusted for price changes.
• Menu costs fall on firms. Shoe leather costs fall mainly on people looking after their money.
• Demand-pull starts with AD. Cost-push starts with AS.

Worked reminders

Real wage

Pay rises from KD 2,000 to KD 2,060 (3%) while the CPI moves from 100 to 104.55. Real pay = 2,060 ÷ 104.55 × 100 = KD 1,970. Pay rose, but real pay fell by about 1.5%.

Cost-push pass-through

A bakery’s weekly costs are KD 1,000: ingredients 400, wages 500, rent and energy 100. Ingredients rise 12% and wages 8%. New costs: 448 + 540 + 100 = KD 1,088, a rise of 8.8%. Average cost per loaf (2,000 loaves) goes from KD 0.50 to KD 0.544.

Menu costs

A café reprints 30 menus at KD 1.50 each (KD 45) and spends 3 staff hours at KD 6 (KD 18). Cost per price change = KD 63. Four changes a year cost KD 252.

Interest and investment

A firm borrows KD 200,000 to buy a machine returning 5% a year (KD 10,000). At 4% interest the cost is KD 8,000, so the firm gains KD 2,000. At 7% the cost is KD 14,000, so it loses KD 4,000 a year.

Exports

A good costs KD 50. Home prices rise 4.55%, so it costs KD 52.28. A rival’s good rises 1%, so it costs KD 50.50. The gap is KD 1.78, so foreign buyers may switch.

Sketch of the AD and AS diagram

The vertical axis shows the general price level and the horizontal axis shows real output. AD slopes downwards and AS slopes upwards. Label the first equilibrium where they cross.

• Demand-pull: shift AD to the right. The new equilibrium has a higher price level and higher output.
• Cost-push: shift AS to the left. The new equilibrium has a higher price level and lower output.

Always label both axes, both curves (old and new) and both equilibrium points.

Evaluation prompts

• How high is inflation, and is it stable and expected?
• What is causing it, and so which policy suits?
• Who gains (borrowers) and who loses (savers, people on fixed incomes)?
• How quickly can wages and prices adjust?
• Is the trade-off with jobs and growth worth it?

Quick self-test

1. Define inflation.
2. A basket has two groups with weights 70 and 30 and indices 102 and 108. Calculate the CPI.
3. The CPI rises from 140 to 147. Calculate the rate of inflation.
4. State two causes of cost-push inflation.
5. Explain one way a cut in interest rates can cause demand-pull inflation.
6. Pay rises 5% while prices rise 3%. Approximately what is the change in the real wage?
7. A loaf cost KD 2.50 and now costs KD 2.75. What is its price index with the old price as 100?
8. State the difference between menu costs and shoe leather costs.
9. Explain why higher inflation than rival countries may reduce exports.
10. A savings account pays 1.5% while inflation is 4%. What happens to the real value of savings?

Answers

1. A sustained rise in the general level of prices.
2. (70 × 102 + 30 × 108) ÷ 100 = (7,140 + 3,240) ÷ 100 = 103.8.
3. 7 ÷ 140 × 100 = 5.0%.
4. Any two: higher wages, higher raw material or energy prices, higher indirect taxes, dearer imported inputs.
5. Borrowing is cheaper, so households and firms spend and invest more, AD rises, and firms near full capacity raise prices.
6. About +2% (5 − 3). Exactly: 1.05 ÷ 1.03 = 1.019, a rise of 1.9%.
7. 2.75 ÷ 2.50 × 100 = 110.
8. Menu costs are firms’ costs of changing prices. Shoe leather costs are the time and effort spent looking for prices or protecting money.
9. Its goods become dearer abroad, so buyers switch to cheaper rivals and export sales fall.
10. It falls, because the real return is about 1.5 − 4 = −2.5 percentage points.

Where marks are usually lost

• Definitions that omit “general” or “sustained”.
• Dividing by the wrong CPI when finding a percentage change.
• Giving an answer of 108 as “108% inflation”.
• Not giving a negative sign for deflation.
• Describing demand-pull and cost-push causes in the wrong curve (AD or AS).
• Stating an effect without the second step that explains why it happens.
• Mixing up menu costs and shoe leather costs.
• Forgetting the real wage. A pay rise is not a gain if prices rose faster.
• Evaluating with a bare “it depends” and no stated factor.

Official syllabus

Pearson Edexcel International GCSE in Economics (4EC1), Specification Issue 3, February 2026, for first teaching September 2017, published by Pearson Education Limited. Section 2.1.1 b), Low and stable inflation.