Question

If the CPI was 110 last year and is 121 this year, what is this year’s inflation rate? In contrast, suppose that the CPI was 110 last year and is 108 this year. What is this year’s inflation rate? What term do economists use to describe this second outcome?

Short answer

If CPI in this year is 121, the inflation rate is 10%.

If CPI in this year is 108, the inflation rate is -1.82%.

The economists call the second outcome as deflation.

Step-by-step solution

Inflation rate when CPI in this year is 121

The inflation rate is the percentage of growth in the price index between two consecutive years.

$$\begin{gathered} \mathrm{Inflation}\mathrm{Rate}=\frac{\mathrm{CPI}\mathrm{in}\mathrm{current}\mathrm{year}-\mathrm{CPI}\mathrm{in}\mathrm{previous}\mathrm{year}}{\mathrm{CPI}\mathrm{in}\mathrm{previous}\mathrm{year}}\times 100 \\ \mathrm{Inflation}\mathrm{Rate}=\frac{121-110}{110}\times 100 \\ =10\% \end{gathered}$$

Therefore, the inflation rate in the present year is 10%.

Inflation rate when CPI this year is 108

If CPI in this year is 108, the inflation will be as follows:

$$\begin{gathered} \mathrm{Inflation}\mathrm{Rate}=\frac{108-110}{110}\times 100 \\ =-1.82\% \end{gathered}$$

Therefore, the inflation rate is -1.82%.

Term used for the second outcome

When the inflation rate is negative (as calculated in step 2), the purchasing power of money increases. The declining inflation rate implies a decline in the general price level, which boosts the purchasing power of the money. This decline in the general price level is called deflation.