How the Rate of Inflation is Calculated
The rate of inflation is a 'weighted mean increase of prices'. It is not the mean increase in prices, because some gods are rarely bought by consumers, so an increase in the price of those goods would not raise the overall price level by much.Suppose people only spend on three things: food, cars and houses.
They spend
\[\frac{1}{6}\]
of their income on good.They spend
\[\frac{1}{3}\]
of their income on cars.They spend
\[\frac{1}{2}\]
of their income on houses.Food prices increase by 10%.
Food prices increase by 20%.
Food prices increase by 30%.
The overall increase in the price level is
\[10 \times \frac{1}{6}+20 \times \frac{1}{3}+30 \times \frac{1}{2}=23.3 \%\]
.