Question

People complain that inflation increases the cost of goods and services and therefore reduces their purchasing power. Explain if this complaint is valid in the following situation: Between 2017 and 2018, the CPI of a small nation rose from 182 to 185. The people’s incomes rose by 3% during that period of time. Explain by using the numbers provided in this example, what happens to their purchasing power.

Answer 1

The cost of living in this economy increased by 1.6%
and the purchasing power of household income rose between 2017 and 2018.

Inflation Rate

=[(CPI of 2018 - CPI of 2017) / CPI of 2018] * 100

= [(185 - 182 ) / 182] * 100

= 1.6%

So, Cost of living has risen by 1.6% from 2017 to 2018

Rise in income by 3% means that purchasing power of people have increased from 2017 to 2018. Rise in income is more than rise in inflation rate. This means purchasing power of people has increased.