5.1 What is inflation?

A semi-circular scale entitled inflation. A needle is moving from green to amder to red.

Inflation measures the changes in the prices of goods and services over time. For most goods and services, prices tend to increase with time.

For example, the average price of 1 kg of potatoes in the UK increased from 32 pence in January 1994 to 93 pence in January 2025 (Office for National Statistics, 2025).

Why is inflation relevant to financial decisions?

Inflation is relevant because increases in prices affect what your money can buy.

For example, suppose the price of an apple is £0.50 and you spend £2 every week buying four apples. If the price increases to £0.60 per apple, then you will not be able to buy 4 apples for £2. This means that an increase in prices (inflation) reduces your purchasing power.

A basket of goods and services

Timing: Allow 2 minutes

Watch this video to learn more about inflation. You will learn that inflation is measured based on the prices of a “basket of goods and services”.

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Learning outcomes

5.2 Interest rates