How is inflation measured?
Correct answer
Answer A: With a price index for a basket.
Quick explanation
A price index tracks how the prices of a defined basket of goods and services change. This makes it possible to calculate the average change in prices.
Detailed explanation
Inflation is usually measured with a price index. Statistical agencies track the prices of a broad basket of goods and services that households typically buy. Not every item has the same importance: categories representing a larger share of average spending receive greater weight.
Those weighted price changes are combined into an index. The inflation rate then states how much the index has changed relative to a comparison period, often the same month of the previous year. The measure therefore tracks a broad price level rather than whether one particular product has become more expensive.
An individual household can experience price changes that differ from the published inflation rate. Someone who spends more than average on a category whose prices rose sharply may face a different burden from the average household. A price index is therefore a standardized average, not an exact description of every person's budget.
Example or everyday application
A simplified basket contains food, housing and transport. Expenses accounting for a larger share of the household budget receive more weight. Changes in weighted prices produce a price index.
Common misconception
The official inflation rate is not a simple average of a few striking price tags and need not exactly match changes in your personal spending.