To understand inflation, one effective method is to track the prices of a selected group of goods over time, which is encapsulated in the Consumer Price Index (CPI). The CPI is a measure that examines the average change over time in the prices paid by consumers for a basket of goods and services. This basket is determined by surveying households to identify typical purchases, which can include items like food and water.

For example, consider a hypothetical family in "Simple Land" that purchases 50 jugs of water and £75 of food in a given year. To calculate the CPI, we first need to determine the cost of this basket of goods for each year. Let's break down the calculations for three consecutive years: 2017, 2018, and 2019.

In 2017, the cost of the basket is calculated as follows:

Cost of water: 50 jugs × $5 = $250

Cost of food: £75 × $20 = $1,500

Total cost for 2017 = $250 + $1,500 = $1,750

Moving to 2018, the prices have changed:

Cost of water: 50 jugs × $5.50 = $275

Cost of food: £75 × $22 = $1,650

Total cost for 2018 = $275 + $1,650 = $1,925

Finally, for 2019, we see further price adjustments:

Cost of water: 50 jugs × $5.20 = $260

Cost of food: £75 × $25 = $1,875

Total cost for 2019 = $260 + $1,875 = $2,135

With these total costs, we can now calculate the CPI for each year. The CPI for a given year can be calculated using the formula:

CPI = (Cost of Basket in Current Year / Cost of Basket in Base Year) × 100

Assuming 2017 is our base year, the CPI calculations would be:

CPI for 2017 = ($1,750 / $1,750) × 100 = 100

CPI for 2018 = ($1,925 / $1,750) × 100 ≈ 110

CPI for 2019 = ($2,135 / $1,750) × 100 ≈ 122

To determine the inflation rate, we can use the CPI values. The inflation rate can be calculated using the formula:

Inflation Rate = ((CPI in Current Year - CPI in Previous Year) / CPI in Previous Year) × 100

Using this formula, we can find the inflation rates for 2018 and 2019:

Inflation Rate from 2017 to 2018 = ((110 - 100) / 100) × 100 = 10%

Inflation Rate from 2018 to 2019 = ((122 - 110) / 110) × 100 ≈ 10.91%

This example illustrates how the CPI is calculated and how it can be used to track inflation over time, providing valuable insights into economic conditions.

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