Definitions of inflation and deflation

Government and the Macroeconomy – Inflation

Objective

Define the terms inflation and deflation and understand how they are measured.

Key Definitions

Inflation

Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. It is usually expressed as an annual percentage change.

The most common way to measure inflation is the inflation rate, calculated from the Consumer Price Index (CPI):

\$\text{Inflation Rate} = \frac{\text{CPI}{t} - \text{CPI}{t-1}}{\text{CPI}_{t-1}} \times 100\%\$

Deflation

Deflation is a sustained decrease in the general price level of goods and services in an economy over a period of time. Like inflation, it is expressed as a percentage change, but the value is negative.

The deflation rate is calculated using the same formula as the inflation rate; a negative result indicates deflation.

Measuring the General Price Level

The Consumer Price Index (CPI) is the most widely used price index for measuring changes in the cost of a typical basket of consumer goods and services.

Why Definitions Matter

• Clear definitions help students distinguish between normal price fluctuations and sustained trends.
• Understanding the measurement formula allows learners to calculate inflation or deflation rates from given CPI data.
• Accurate definitions provide a foundation for later topics such as causes, consequences, and policy responses.