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

This guide follows the OCR A Level Economics (H460) specification, Version 3.0, dated June 2026 and first assessed in 2021. It teaches the topic Inflation within Component 2, Macroeconomics (H460/02), under Economic policy objectives and indicators of macroeconomic performance. No content is labelled AS or Extension. Every country, firm and number below is invented for illustration.

Related: the revision notes, the practice set, the Macroeconomics overview, the hub for OCR A Level Economics, the printable checklist and the free diagnostics.

What this unit covers

Outcome in the specification	Section below
Explain inflation and the objective of low and stable inflation	1
Explain deflation, disinflation and hyperinflation	2
Explain how the current official UK measure of inflation is constructed	3
Calculate the rate of inflation and real values using index numbers	4 and 5
Evaluate the advantages and disadvantages of an index such as CPI and the Retail Prices Index	6
Evaluate the causes of inflation	7
Evaluate the consequences of inflation	8
Evaluate the causes and consequences of deflation	9

The specification also lists “calculate and interpret index numbers” as a quantitative skill.

1. Inflation and the policy objective

Inflation is a continuing rise in prices across the economy as a whole. The inflation rate is the percentage change in a price index over a period, usually a year. A rise in one price is not inflation.

The macroeconomic objective is low and stable inflation, not zero inflation. The reasons:

• Low inflation protects the purchasing power of incomes and savings.
• Stable inflation lets households and firms predict prices, which helps contracts, wage bargains and investment.
• A little inflation leaves room for real wages to adjust without money pay being cut, and keeps the economy away from deflation.

2. Deflation, disinflation and hyperinflation

• Deflation is a continuing fall in average prices across the economy. The inflation rate is negative.
• Disinflation is a slowdown in the rate of inflation. Prices still rise, only more slowly.
• Hyperinflation is extremely rapid and usually accelerating inflation. The specification gives no threshold. A common rule of thumb is more than 50% a month.

Worked example (Country Z, invented). Take a price index of 100 and inflation of 9.0%, 5.0% and 2.5% in three successive years.

Year 1: 100 × 1.090 = 109.00
Year 2: 109.00 × 1.050 = 114.45
Year 3: 114.45 × 1.025 = 117.31

The rate falls every year (disinflation), but the index keeps rising, so there is no deflation. If an index drops from 118.6 to 116.2, the rate is (116.2 − 118.6) ÷ 118.6 × 100 = −2.0%.

Hyperinflation compounds. At 50% a month, a loaf costing 10 z becomes 10 × 1.5 = 15 z after one month, and after 12 months costs 10 × 1.5¹² = 1,297 z.

3. How the official UK measure is constructed

The current official measure is the Consumer Prices Index (CPI). It tracks what a typical household’s basket of goods and services costs. The steps:

1. Choose the basket of items households buy. It is reviewed so new products can enter and old ones leave.
2. Collect prices for those items regularly from sellers.
3. Combine prices for similar items, then group them into broad categories.
4. Give each category a weight equal to its share of household spending, taken from spending surveys and updated regularly.
5. Set a base year equal to 100 and express later years against it.

A category index is a price relative. A bus pass costs 80 z in the base year and 99.2 z now, so its index is 99.2 ÷ 80 × 100 = 124.0.

Worked example: building a weighted index (Country Z, base year = 100).

Category	Weight	Index now	Weight × index
Food and drink	22	118	2,596
Housing and utilities	27	109	2,943
Transport	18	124	2,232
Clothing	8	96	768
Recreation	14	112	1,568
Other	11	105	1,155
Total	100		11,262

Index = 11,262 ÷ 100 = 112.62. Average prices are 12.62% above the base year. Transport rose most, but food and drink had almost as large an effect because its weight is larger. Clothing fell and pulled the index down.

4. Calculating the rate of inflation

inflation rate (%) = (new index − old index) ÷ old index × 100

Worked example. Country Z’s index is 127.5 in year 1 and 133.0 in year 2.

• Change = 133.0 − 127.5 = 5.5
• Rate = 5.5 ÷ 127.5 × 100 = 4.3% (1 d.p.)

If the index is then 139.4 in year 3: (139.4 − 133.0) ÷ 133.0 × 100 = 4.8%. Inflation has risen.

An index of 133 does not mean 133% inflation. It means prices are 33% above the base year.

Rebasing. An index with 2018 = 100 reads 136.8 in 2022 and 148.5 in 2024. To make 2022 the base, divide each value by 136.8 and multiply by 100: 148.5 ÷ 136.8 × 100 = 108.55. Prices rose 8.55% from 2022 to 2024.

5. Calculating real values

A nominal (money) value is measured at the prices of the year it occurs. A real value is adjusted for price changes so that it can be compared across years.

real value = nominal value ÷ price index × 100

Worked example. A worker earns 2,400 z a month in year A, when the index is 100. In year B she earns 2,760 z and the index is 121.4.

• Nominal pay rose (2,760 − 2,400) ÷ 2,400 = 15.0%.
• Real pay in year A prices = 2,760 ÷ 121.4 × 100 = 2,273 z.
• Real change = (2,273 − 2,400) ÷ 2,400 × 100 = −5.3%.

Pay rose 15% but prices rose 21.4%, so she can buy less.

6. Evaluating CPI and RPI

CPI and the Retail Prices Index (RPI) both measure the cost of a basket but differ in construction.

Feature	CPI	RPI
Averaging method for most items	Geometric mean	Arithmetic mean
Owner-occupier housing costs	Almost entirely excluded	Included, such as mortgage interest
Council tax	Excluded	Included
Households covered	Very wide, including visitors to the UK	Excludes the top 4% of households by income and pensioner households mainly dependent on state benefits

A further index, CPIH, adds owner-occupier housing costs to the CPI approach.

For CPI: it follows harmonised international rules, so UK inflation can be compared with other countries’. It covers almost all households.

Against CPI: it leaves out most housing costs of homeowners with mortgages, so it can understate their experience.

For RPI: it includes housing costs, so it fits homeowners more closely.

Against RPI: its arithmetic averaging tends to push the figure up, and it excludes some households.

Weaknesses of any index. The basket is an average. A pensioner, a student and a commuter spend very differently, so personal inflation differs from the headline. Quality changes make comparisons hard. New products take time to enter, and shoppers switch to cheaper goods, which a fixed basket misses. Judgement: CPI suits policy and comparison; RPI or CPIH says more about housing-heavy budgets. State whose cost of living you are measuring.

7. Causes of inflation

Demand-pull inflation. Aggregate demand (AD) rises faster than productive capacity. In the AD and AS diagram, the AD curve shifts right along short-run aggregate supply (SRAS). The price level rises from P1 to P2 and real output from Y1 to Y2. Nearer full capacity SRAS is steeper, so more of the rise goes to prices.

Triggers: lower interest rates, faster credit growth, higher government spending or lower taxes, and a weaker currency boosting exports.

Cost-push inflation. SRAS shifts left because production costs rise. The price level rises and real output falls. Triggers: wages rising faster than productivity, dearer raw materials or energy, higher indirect taxes and a falling exchange rate.

Worked example 1 (wages and productivity). Wages rise 6% and output per worker 2%. Unit labour costs rise by 1.06 ÷ 1.02 − 1 = 3.9%. If firms pass that on, prices rise even with weak demand.

Worked example 2 (exchange rate). A firm imports a part priced at 45 foreign units. At 1.50 foreign units per z the cost is 45 ÷ 1.50 = 30 z. The currency depreciates to 1.20 foreign units per z. The cost becomes 45 ÷ 1.20 = 37.5 z, a rise of 25%, though the foreign price did not change.

Monetary and expectations causes. If the money supply grows much faster than real output, spending outpaces goods and prices rise. If people expect higher inflation, workers demand higher pay and firms raise prices in advance (a wage-price spiral).

Evaluation. The causes interact: a demand boom lets firms pass on costs and workers win pay rises. Judge how much spare capacity exists, how elastic SRAS is, whether the shock is one-off (a tax rise) or persistent, and whether expectations adjust.

8. Consequences of inflation

Group	Possible effects
Consumers and workers	Falling real income if pay lags prices. Fixed-income households lose most. Menu and shoe-leather costs.
Savers and borrowers	Savers lose if interest is below inflation. Borrowers with fixed repayments gain.
Firms	Uncertainty weakens investment. Higher input costs. Exports dearer abroad if inflation is above rivals’ and the exchange rate does not adjust.
Government	The real value of government debt falls. Fiscal drag pulls more people into higher tax. Spending costs rise.

Worked example 1 (real interest). A savings rate of 2% with 6% inflation gives a real return of 1.02 ÷ 1.06 − 1 = −3.8%. A saver with 36,000 z ends with 36,720 z, which buys what 36,720 ÷ 1.06 = 34,642 z bought before. She is poorer in real terms.

Worked example 2 (debt). A fixed debt of 150,000 z with 5% inflation has a real value of 150,000 ÷ 1.05⁴ = 123,405 z after four years, a fall of 17.7%.

Worked example 3 (fiscal drag). Income tax is 20% above a fixed 12,000 z threshold. Pay rises from 20,000 z to 21,000 z (5%, matching inflation). Tax rises from 1,600 z to 1,800 z. The tax share rises from 8.0% to 8.6% of income, though real pay is unchanged.

Hyperinflation destroys money’s usefulness: people barter or use foreign currency, savings are wiped out and output falls.

Evaluation. Effects depend on the rate, whether inflation is anticipated, whether wages and interest rates adjust, inflation abroad and the cause. Low, anticipated inflation has small costs; high, volatile, unanticipated inflation has large ones.

9. Causes and consequences of deflation

Causes. (1) A fall in AD: weak consumer spending, falling asset prices, tight fiscal or monetary policy. (2) A rise in SRAS or long-run aggregate supply from lower costs, productivity gains or cheaper imports. (3) An appreciating currency that lowers import prices.

Consequences.

• Postponed spending. A buyer expects a 2,000 z television to fall 4% to 1,920 z and waits, saving 80 z. If many wait, AD falls further.
• Rising real debt. A fixed debt of 150,000 z with prices falling 3% a year for three years has a real value of 150,000 ÷ 0.97³ = 164,352 z, up 9.6%. Real interest rates also rise.
• Profits and jobs. Revenues fall while costs such as loans do not, so firms cut output, investment and jobs.
• Gains. Real incomes of those with stable pay rise, and exports can become cheaper.

Evaluation. Deflation from falling demand is damaging. Deflation from supply gains can come with growth and rising employment. The key questions are the cause, its size and its persistence.

Common errors

• Calling a lower rate of inflation deflation.
• Dividing by the new index instead of the old one in the rate formula.
• Treating an index of 133 as a rate.
• Listing effects without saying who is affected and how.

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.