Chapter 14: Inflation and the Price Level

What you'll learn in this chapter

• explain what inflation is and distinguish common causes (demand-pull, cost-push, imported, policy-induced)
• analyse the effects of price level changes on consumers, firms and the wider economy
• understand how inflation is measured (e.g. CPI vs HICP in an EU context)
• outline the role of the ECB in maintaining price stability

Core ideas

Inflation is about sustained rises in the general price level. You’ll link inflation to purchasing power, competitiveness, wage demands, savings/real returns, and Ireland’s attractiveness for trade and FDI.

Exam focus

• definitions + classification: identify which type of inflation fits a scenario
• effects question: consumers vs firms vs economy (include competitiveness/FDI)
• EU angle: why HICP matters for comparing inflation across member states

Interactive: CPI & Real Interest Rates

Two essential tools for measuring and adjusting for inflation. The CPI measures price changes over time; the Fisher equation separates nominal from real interest rates.

Consumer Price Index (CPI)

CPI = (Cost of basket in current year ÷ Cost in base year) × 100. The base year always equals 100.

Inflation rate: +8.0% since the base year.

Fisher Equation — Real Interest Rate

Real rate ≈ Nominal rate − Inflation rate. Corrects for the erosion of purchasing power.

Real rate = 5.5% − 2.0% = 3.5% — the true return after accounting for inflation.