The government objective of controlling inflation: the meaning of inflation, how it is measured by the CPI, its causes, and its effects on the economy.

What this dot point is asking

The SQA wants you to define inflation, explain how it is measured by the Consumer Prices Index, set out its main causes, and explain its effects - so you can see why keeping inflation low and stable is a key government objective.

What inflation is

Inflation is not a one-off price rise on a single good; it is a sustained increase in the general (average) level of prices across the economy over time. When prices rise, each pound buys less, so inflation reduces the purchasing power (real value) of money.

The government's objective is low and stable inflation, not zero. A small, steady rise in prices is normal in a growing economy; the problem is when inflation is high or unpredictable.

How inflation is measured: the CPI

The UK's main measure of inflation is the Consumer Prices Index (CPI).

The causes of inflation

National 5 expects you to know the two main causes.

• Demand-pull inflation happens when total demand in the economy rises faster than supply can meet it. With "too much money chasing too few goods", firms raise prices. It is associated with a booming economy, low unemployment and rising consumer or government spending.
• Cost-push inflation happens when the costs of production rise - higher wages, raw materials, energy or import prices - and firms pass these costs on as higher prices. A rise in oil or energy prices is a classic cause.

The effects of inflation

High or unstable inflation harms different groups in different ways:

• Consumers find their money buys less, so real living standards fall - worst for those on fixed incomes such as pensioners.
• Savers lose if the interest they earn is below the inflation rate, because the real value of their savings falls; borrowers may gain, as the real value of their debt shrinks.
• Firms and exports suffer because rising UK prices make exports dearer and less competitive abroad, and uncertainty about future prices discourages firms from investing.
• Workers may demand higher wages to keep up, which can feed further cost-push inflation in a "wage-price spiral".

Why this matters across the course

Controlling inflation is one of the government's main economic objectives, alongside employment and growth in the next dot point. The tools to manage it (taxation and spending) come from the government finance dot point, and inflation links to the global economy through import prices and exchange rates. It also reaches every household through purchasing power, connecting back to personal economics.

Try this

Q1. Define inflation. [2 marks]

• Cue. A sustained rise in the general level of prices, reducing the purchasing power of money.

Q2. Name the index used to measure inflation in the UK and what it tracks. [2 marks]

• Cue. The Consumer Prices Index (CPI); the cost of a weighted basket of goods and services.

Q3. Explain one effect of high inflation on savers. [2 marks]

• Cue. If interest is below inflation, the real value of savings falls, so savers can buy less with them later.