OCR A Level Economics: Inflation, deflation and index numbers (H460) – Revision Notes

These notes condense the topic Inflation from Component 2, Macroeconomics (H460/02), of the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), first assessed in 2021. For full explanations and longer worked examples, read the study guide. Test yourself with the practice set, then use the hub for OCR A Level Economics, the checklist and the free diagnostics. All figures here are invented.

Definitions

Term	Meaning
Inflation	A continuing rise in prices across the whole economy
Inflation rate	Percentage change in a price index over a period
Low and stable inflation	The policy objective: a low rate that is predictable, not zero
Deflation	A continuing fall in average prices (negative inflation)
Disinflation	A slowdown in the rate of inflation. Prices still rise
Hyperinflation	Extremely rapid, usually accelerating, inflation. Rule of thumb: over 50% a month
Nominal value	Measured at the prices of the year it occurs
Real value	Adjusted for price changes

Why not zero inflation? A little inflation lets real wages adjust without cutting money pay and keeps the economy away from the risks of deflation.

Distinctions to keep straight

• Disinflation versus deflation. Inflation falls from 6% to 2%: disinflation, the price level still rises. Inflation of −1%: deflation, the price level falls.
• Index versus rate. An index of 108 says prices are 8% above the base year. The inflation rate compares two index values.
• Nominal versus real. Pay up 4% with prices up 6% means falling real pay.
• Demand-pull versus cost-push. Demand-pull shifts AD right and raises output as well as prices. Cost-push shifts SRAS left and lowers output while prices rise.
• CPI versus RPI. Different averaging methods, different treatment of housing, different household coverage.

Method boxes

Inflation rate

1. Write the old and new index values.
2. New minus old.
3. Divide by the old value.
4. Multiply by 100 and state “%”.

Real value

1. Take the nominal value.
2. Divide by the price index.
3. Multiply by 100.
4. Compare with the earlier real value, or with the base-year value.

Weighted index

1. Multiply each category index by its weight.
2. Add the products.
3. Divide by the total of the weights.

Rebasing. Divide every value by the value of the new base year and multiply by 100.

Worked reminders

Rate: an index goes from 150 to 156. (156 − 150) ÷ 150 × 100 = 4.0%.

Real value: pay rises from 33,000 z to 36,300 z (+10%) while the index goes from 100 to 112. Real pay = 36,300 ÷ 112 × 100 = 32,411 z, a fall of 1.8%, so real pay fell although the pay packet rose.

Weighted index: weights 60 and 40, indices 110 and 95. (60 × 110 + 40 × 95) ÷ 100 = (6,600 + 3,800) ÷ 100 = 104.0.

Compounding: 20% a month for three months turns a 50 z item into 50 × 1.2³ = 86.4 z.

Real interest: a 6% savings rate with 2.5% inflation gives 1.06 ÷ 1.025 − 1 = 3.4% exactly, and the subtraction shortcut gives 3.5 percentage points.

How the official UK measure is built

CPI tracks the cost of a basket of goods and services. The steps: choose the basket, collect prices regularly, combine similar items, group into categories, weight each category by its share of household spending, and set a base year to 100. The basket and weights are updated so the index follows changing spending patterns.

	CPI	RPI
Averaging of prices	Geometric mean	Arithmetic mean
Owner-occupier housing costs	Almost entirely excluded	Included
Council tax	Excluded	Included
Households	Very wide	Excludes the top 4% by income and some pensioner households

• For CPI: harmonised international rules help comparison, wide coverage.
• Against CPI: misses homeowners’ housing costs.
• For RPI: captures housing costs.
• Against RPI: arithmetic averaging tends to give higher figures, and some groups are missing.
• Weaknesses of both: average basket hides differences between households, quality change is hard to price, new products enter late, shoppers switch to cheaper goods.

Causes of inflation

Cause	Chain of reasoning
Demand-pull	Lower interest rates, tax cuts, more government spending, credit growth or a weaker currency raise AD, spare capacity falls, firms raise prices
Cost-push	Higher wages (faster than productivity), raw materials, energy, indirect taxes or import prices raise unit costs, SRAS shifts left, firms pass costs on
Imported	A currency fall raises the domestic price of imports. Check: 45 foreign units at 1.50 per z costs 30 z; at 1.20 per z it costs 37.5 z, up 25%
Money supply	Money growing faster than output lets spending chase too few goods
Expectations	Expected inflation feeds wage claims and price rises, so inflation persists

Evaluate by asking: is there spare capacity? Is SRAS steep or flat? Is the shock one-off or persistent? Do wages and expectations adjust? Which cause came first?

Consequences of inflation

• Households: real incomes fall if pay lags prices; fixed incomes lose most; savers lose if the real rate is negative; borrowers on fixed rates gain.
• Firms: uncertainty reduces investment; menu costs; competitiveness falls if inflation exceeds rivals’ and the exchange rate does not offset it.
• Government: the real value of debt falls; fiscal drag raises the tax share; costs rise.
• Hyperinflation: loss of confidence in money, wiped-out savings, barter, collapse of output.

Evaluate by asking: how high is it, is it anticipated, who is affected, do interest rates and wages adjust, and what is happening abroad?

Causes and consequences of deflation

• Causes: weak AD (falling spending, asset prices, tight policy), growth in supply (lower costs, productivity), an appreciating currency.
• Harmful effects: postponed purchases, higher real debt burden (debt of 80,000 z with prices down 2% has a real value of 80,000 ÷ 0.98 = 81,633 z), higher real interest rates, squeezed profits, falling output and jobs.
• Gains: higher real income for people with stable pay, lower export prices.
• Evaluate: deflation from weak demand is damaging; deflation from supply growth can accompany rising output. The cause and persistence decide.

Chains of reasoning to rehearse

Demand-pull. Lower interest rates, so cheaper borrowing, so higher consumption and investment, so AD shifts right, so output nears capacity, so firms with less spare capacity raise prices and bid for labour, so wages and costs rise. Evaluate: if SRAS is flat because spare capacity exists, output rises with little inflation.

Cost-push. Energy price rise, so unit costs rise, so SRAS shifts left, so price level up and output down. Evaluate: a one-off rise lifts the price level once, while inflation persists only if wage claims and expectations follow.

Inflation harms competitiveness. Domestic prices rise faster than abroad, so exports are dearer and imports cheaper, so net exports fall, so AD and jobs fall. Evaluate: a depreciating currency can offset this, though it raises import costs.

Deflation spiral. Prices expected to fall, so spending is postponed, so AD falls, so firms cut prices and jobs, so incomes fall, so prices fall further. Evaluate: this needs expectations of falling prices to be widespread and lasting.

Quick self-test

1. Define disinflation.
2. An index rises from 96.0 to 99.2. Calculate the inflation rate to one decimal place.
3. Nominal wages are 1,500 z when the index is 125 (base 100). Calculate the real wage.
4. An index (2020 = 100) is 120 in 2023 and 132 in 2025. Rebase it so that 2023 = 100 and give the value for 2025.
5. Weights of 60 and 40 go with indices of 110 and 95. Calculate the weighted index.
6. State two differences between CPI and RPI.
7. State the difference between the effect on real output of demand-pull and cost-push inflation.
8. A debt of 80,000 z is fixed. Prices fall 2%. What is its real value afterwards?
9. A 50 z item rises in price by 20% a month for three months. What does it cost?
10. A savings rate of 6% and inflation of 2.5%. Calculate the exact real return.
11. Give one way deflation can be beneficial.

Answers

1. A slowdown in the rate of inflation; prices still rise.
2. (99.2 − 96.0) ÷ 96.0 × 100 = 3.3%.
3. 1,500 ÷ 125 × 100 = 1,200 z.
4. 132 ÷ 120 × 100 = 110.
5. (6,600 + 3,800) ÷ 100 = 104.0.
6. Any two of: geometric versus arithmetic averaging; owner-occupier housing costs and council tax excluded from CPI but included in RPI; RPI excludes the top 4% of households by income and some pensioner households.
7. Demand-pull raises output as well as prices, while cost-push lowers output.
8. 80,000 ÷ 0.98 = 81,633 z (rounded), a rise of about 2.0%.
9. 50 × 1.2³ = 86.4 z.
10. 1.06 ÷ 1.025 − 1 = 3.4%.
11. For example, deflation caused by productivity gains lowers prices and raises real incomes, or it makes exports cheaper.

Where marks are usually lost

• Calling a slowdown in inflation deflation.
• Dividing by the new index value when finding a rate.
• Treating an index of 120 as 120% inflation.
• Forgetting to multiply by 100 in real value calculations.
• Using the wrong base year when comparing two years.
• Describing demand-pull and cost-push with no AD or SRAS shift.
• Listing effects of inflation without saying who gains and who loses.
• Concluding without judging which effect is bigger and why.
• Stating that CPI is “better” without saying for whom or for what purpose.
• Omitting units or the word “real” when comparing wages.

Official syllabus

OCR, A Level Economics (H460) specification, Version 3.0 (June 2026), first assessment 2021, Component 2 (H460/02), Economic policy objectives and indicators of macroeconomic performance, topic Inflation.