✓ Revise Right course
Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. Free GCSE Economics notes.
Understanding Inflation and Price Stability is part of Price stability in GCSE OCR Economics.
8 min
Reading time
25
Lessons in this topic
GCSE OCR
Pathway
Reviewed by Revise Right
Content review
Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. Free GCSE Economics notes.
Use this lesson to stay inside Price stability while connecting the detail back to the wider Economic objectives and the role of government topic.
Read the core explanations from Understanding Inflation and Price Stability before testing yourself from memory.
Have you noticed that a meal deal that used to cost £3.00 now costs £3.60? Or that your parents complain about the weekly food shop getting more expensive? That is inflation in action. Inflation affects every single person in the economy, from the price of your bus fare to the interest rate on a savings account. Understanding inflation is essential for GCSE Economics and for making sense of the UK economy.
In 2022 and 2023, UK inflation reached levels not seen for over 40 years, peaking at 11.1% in October 2022. The Bank of England's target for inflation is 2%. When inflation is well above that target, it creates serious problems for households, businesses and the government. By the end of this lesson, you will understand exactly why.
The rate of inflation tells us how quickly prices are rising. It is expressed as a percentage. If the rate of inflation is 3%, it means that the general price level has risen by 3% compared to the same time last year. The Bank of England has a target inflation rate of 2%, which the government considers to be the right level for a stable, growing economy.
The CPI works in three main stages:
Step 1 — Choose the basket: The ONS selects around 700 goods and services that represent what a typical UK household spends money on. This includes food, clothing, housing costs, transport, entertainment and more. The basket is updated every year to reflect changing spending habits. For example, streaming subscriptions were added to the basket in recent years, while DVD players were removed.
Step 2 — Collect prices: Each month, price collectors record the prices of these items from shops, websites and service providers across the country.
Step 3 — Weight and calculate: Items are given different weightings based on how much of a household's income is typically spent on them. Housing and food have large weightings because households spend a lot on these. The weighted prices are combined into a single index number.
The CPI uses a base year, where the index is set to 100. If the CPI rises to 105 the next year, it means prices have risen by 5% on average since the base year. The formula for calculating the rate of inflation from CPI figures is:
Rate of inflation = ((New CPI - Old CPI) / Old CPI) x 100
| Year | CPI Value | Rate of Inflation |
|---|---|---|
| 2020 (base year) | 100.0 | — |
| 2021 | 102.5 | 2.5% |
| 2022 | 112.8 | 10.0% |
| 2023 | 120.5 | 6.8% |
| 2024 | 123.7 | 2.7% |
Notice something important in the table above: the CPI kept rising from 2022 to 2023 (from 112.8 to 120.5), but the rate of inflation fell (from 10.0% to 6.8%). This is because inflation measures the speed of price increases, not the level of prices itself. Prices were still going up, just more slowly. This distinction trips up many GCSE students.
Worked example: Calculating the Rate of Inflation Using CPI
In 2022, the CPI was 112.8. In 2023, the CPI rose to 120.5. Calculate the rate of inflation between 2022 and 2023. Show your working.
Method: Use the inflation rate formula with the CPI figures
Answer: The rate of inflation between 2022 and 2023 was 6.8%.
Economists identify two main causes of inflation. Think of it this way: prices can be pushed up from the supply side, or pulled up from the demand side.
| Feature | Cost-Push Inflation | Demand-Pull Inflation |
|---|---|---|
| Cause | Rising production costs | Excess aggregate demand |
| Side of the economy | Supply side | Demand side |
| Trigger examples | Higher oil prices, rising wages, weaker pound | Low interest rates, rising consumer confidence, government spending boom |
| Effect on output | Output may fall (stagflation) | Output may rise initially before inflation takes hold |
| UK 2022 example | Soaring energy prices after the Russia-Ukraine conflict | Post-COVID pent-up consumer demand and government furlough spending |
The UK's 2022-2023 inflation spike was caused by both types of inflation happening at the same time. On the cost-push side, the Russia-Ukraine conflict caused energy prices to soar, and post-Brexit supply chain disruptions raised import costs. On the demand-pull side, the economy was recovering from COVID-19, with consumers spending savings built up during lockdowns and the government's furlough scheme putting money into the economy.
Worked example: Identifying the Cause of Inflation
A country's main export earner is oil. Global oil prices fall by 40%, reducing the country's export revenue. At the same time, a new minimum wage law increases labour costs by 15%. Explain which type of inflation is most likely to occur and why. [4 marks]
Method: Identify the type of inflation by analysing whether the cause is on the supply side or demand side
Answer: Cost-push inflation is most likely to occur. The 15% increase in labour costs raises the costs of production for firms across the economy. Firms respond by increasing their prices to maintain profit margins, pushing the general price level upward. While falling oil prices might offset some cost increases, the minimum wage rise affects all sectors using labour.
Inflation does not affect everyone equally. Some groups lose out, while others may actually benefit. Understanding these different impacts is crucial for evaluation questions in the exam.
| Group | Negative Consequences | Possible Benefits |
|---|---|---|
| Consumers | Reduced purchasing power — each pound buys less. Those on fixed incomes (e.g., pensioners) are hit hardest. The cost of living rises. | Homeowners may see the real value of their mortgage debt fall if inflation exceeds their interest rate. |
| Producers | Higher costs of raw materials and wages squeeze profit margins. Uncertainty makes long-term planning and investment difficult. Menu costs arise from constantly updating prices. | Firms may benefit if they can raise prices faster than their costs rise, temporarily increasing profits. |
| Workers | If wages do not keep pace with inflation, real wages fall — workers can buy less even if their nominal pay stays the same. Risk of a wage-price spiral. | Workers with strong bargaining power (e.g., in trade unions) may negotiate wage rises above inflation. |
| Savers | The real value of savings is eroded. If inflation is 5% and the savings interest rate is 2%, savers lose 3% of their purchasing power each year. | Very few benefits for savers during high inflation. |
| Borrowers | Interest rates may rise as the Bank of England tries to control inflation, increasing repayment costs. | The real value of debt falls — borrowers repay in pounds that are worth less than when they originally borrowed. |
| Government | Government spending rises (e.g., state pensions and benefits linked to inflation). Uncertainty may reduce economic growth. | Tax revenues may rise if wages and profits increase in nominal terms (fiscal drag). The real value of government debt falls. |
The wage-price spiral: This is a particularly dangerous consequence of inflation. It works like this: prices rise, so workers demand higher wages to maintain their living standards. Higher wages increase firms' costs, so firms raise prices further. This triggers another round of wage demands. The spiral can be very difficult to stop and was a major concern during the UK's 2022-2023 inflation episode, when strikes by nurses, teachers, rail workers and others reflected demands for pay rises to keep up with the cost of living.
The UK government sets the Bank of England an inflation target of 2% (measured by CPI). This target exists because a small, stable amount of inflation is considered healthy for the economy — it encourages spending and investment. However, if inflation rises significantly above 2%, the Bank of England will raise interest rates to cool demand and bring inflation back down.
During 2022-2023, the Bank of England raised its base interest rate from 0.1% to 5.25% in an attempt to bring inflation under control. Higher interest rates make borrowing more expensive and saving more attractive, which reduces consumer spending and helps to slow down demand-pull inflation. However, higher interest rates are less effective against cost-push inflation because they do not directly reduce the cost of energy or raw materials.
Top tips for inflation questions:
1. Always define inflation precisely — it is a sustained increase in the general price level.
2. When doing CPI calculations, always divide by the OLD CPI, not the new one.
3. Remember that falling inflation does NOT mean prices are falling — it means prices are rising more slowly.
4. In evaluation questions, always consider who wins and who loses from inflation. Borrowers and the government may benefit; savers and those on fixed incomes lose out.
5. Link to UK context: mention the Bank of England's 2% target and the 2022-2023 inflation spike where relevant.
Published by Revise Right. Use the official specification reference to check the requirements for your course. Content updated: 2026-03-24.
Move to the related lessons or back to the topic page when you need the wider sequence before exam-style practice.
Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. It means that, on average, prices are rising and each pound buys fewer goods than before. The Bank of England's target is 2%.
The Bank of England's inflation target is 2%, measured by CPI. A small, stable amount of inflation is considered healthy because it encourages spending and investment.
Cost-push inflation is caused by rising costs of production, such as higher oil prices, wages or import costs, which firms pass on as higher prices. Demand-pull inflation is caused by aggregate demand growing faster than the economy's ability to supply goods, so too much money chases too few goods.
The basket of goods is around 700 goods and services that represent what a typical UK household spends money on, used to calculate CPI. The ONS updates it each year, adding items like streaming subscriptions and removing items like DVD players.
Inflation hurts savers, whose savings lose real value, and people on fixed incomes such as pensioners, while workers lose out if wages do not keep pace. Borrowers can benefit because the real value of debt falls, and the government may gain tax revenue through fiscal drag.
Rate of inflation = ((new CPI - old CPI) ÷ old CPI) x 100. If the CPI rose from 112.8 to 120.5, the rate of inflation = (7.7 ÷ 112.8) x 100 = 6.8%. Always divide by the old CPI, not the new one.
The Consumer Price Index (CPI) measures inflation by tracking price changes in a representative basket of around 700 goods and services that a typical UK household buys. The ONS collects prices each month, weights items by how much households spend on them, and updates the basket each year.
UK inflation peaked at 11.1% in October 2022, a level not seen for over 40 years. This was far higher than the Bank of England's 2% target.
Falling inflation does not mean prices are falling; it means prices are rising more slowly. In the CPI example, the index rose from 112.8 to 120.5 between 2022 and 2023, but the inflation rate fell from 10.0% to 6.8%.
A wage-price spiral is when rising prices lead workers to demand higher wages, which raise firms' costs, so firms raise prices further, triggering more wage demands. It can be very difficult to stop.
Inflation erodes the real value of savings. If inflation is 5% and the savings interest rate is 2%, savers lose 3% of their purchasing power each year.
Inflation can help borrowers because the real value of debt falls: they repay in pounds worth less than when they borrowed. However, interest rates may rise as the Bank of England tries to control inflation, increasing repayment costs.
Higher interest rates reduce inflation by making borrowing more expensive and saving more attractive, which cuts consumer spending and slows demand-pull inflation. The Bank of England raised its base rate from 0.1% to 5.25% during 2022-2023.
A base year is the year when the CPI is set to 100, so later values show the change in prices since then. If the CPI rises to 105 the next year, prices have risen by 5% on average since the base year.
UK inflation in 2022 was caused by both cost-push and demand-pull factors. Energy prices soared after the Russia-Ukraine conflict and post-Brexit supply chain disruptions raised import costs, while consumers spent lockdown savings as the economy recovered from COVID-19.