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IB DP Economics — Unit 3: Macroeconomics | SL | 3.3 Macroeconomic Objectives
📋 What You Will Learn
- Define inflation and explain why it is a key macroeconomic objective
- Explain how the Consumer Price Index (CPI) is constructed and used to measure inflation
- Calculate the inflation rate using CPI data
- Analyse the limitations of the CPI as a measure of the true cost of living
- Distinguish between inflation, deflation, and disinflation
- Evaluate the significance of accurate inflation measurement for households, firms, and governments
🔍 Guiding Question Can a single number ever accurately capture the rising cost of living for millions of different households — and what are the consequences when it cannot?
🌍 Why This Matters In 2022–23, the UK's official CPI inflation peaked at 11.1% — the highest in 41 years. Yet millions of low-income households reported that their actual cost of living had risen by far more, because they spend a larger share of income on energy and food, which rose by over 50%. The official number was real — but for many people, it dramatically understated their experience of inflation.
What Is Inflation?
Prices change constantly in a market economy. The question is whether the general price level — across the whole economy — is rising, falling, or stable. Inflation is the sustained upward movement in that general price level over time.
📖 Definition — Inflation Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time, resulting in a fall in the purchasing power of money.
Two related terms are frequently confused with inflation and must be distinguished precisely:
📖 Definition — Deflation Deflation is a sustained decrease in the general price level — a negative rate of inflation. It is associated with falling demand, rising real debt burdens, and can trigger a deflationary spiral.
📖 Definition — Disinflation Disinflation is a reduction in the rate of inflation — prices are still rising, but more slowly than before. For example, inflation falling from 8% to 4% is disinflation, not deflation.
💡 Key Distinction: Inflation vs Disinflation vs Deflation
- Inflation: price level rising (e.g. CPI = +6% this year)
- Disinflation: price level still rising, but at a slower rate (e.g. CPI falls from +6% to +3%)
- Deflation: price level falling (e.g. CPI = −1%)
📖 Definition — Purchasing Power Purchasing power refers to the quantity of goods and services that a unit of money can buy. When inflation rises, the purchasing power of money falls — the same nominal amount buys less in real terms.
Why Does Inflation Matter?
- Households: inflation erodes real incomes — if wages rise by 3% but prices rise by 6%, real purchasing power falls by approximately 3%
- Savers: inflation reduces the real value of savings — money held in low-interest accounts loses purchasing power
- Borrowers: