Exercises: Inflation and purchasing power

Explain what inflation is and how it differs from a price increase in a single product: inflation is a general and sustained rise in almost all prices. Give two examples of each case (petrol prices rising due to a fault at a refinery; bread, bus fares, cinema tickets, and clothes all rising at the same time).

The CPI is calculated by tracking the "shopping basket" of a typical family: the prices of hundreds of products are recorded every month.

1. a) Explain how this basket allows us to measure inflation.
2. b) Reason why the inflation felt by your grandmother (medicines, doctors, electricity) might be different from yours (leisure, technology, clothes).

The figure shows the inflation of a European country over the last five years: how much prices rose each year. In $2025$, the shopping basket that cost $100\ \text{€}$ in January cost $102\ \text{€}$ in December.

1. a) Calculate the inflation for $2025$, which is the missing figure in the chart.
2. b) State in which year prices shot up the most, and explain what happened that year to families whose wages did not increase.

Your grandfather says: 'With $1.000$ pesetas ($6\ \text{€}$) I went to the cinema, had an afternoon snack and came back by taxi.'

1. a) Explain with the example what purchasing power is (what you can actually buy with an amount of money) and why it falls with inflation even though the banknote is the same.
2. b) Make a list of what you can buy today with $10\ \text{€}$ and argue what a teenager will say about you in $20$ years' time.

The CPI is calculated in Spain by the National Statistics Institute (INE): every month, surveyors note the price of hundreds of products in thousands of shops across the country.

1. a) Explain why measuring inflation requires that fieldwork and why looking at a single product is not enough.
2. b) Argue what would happen to the CPI if only the prices of online shops were measured.

Besides the general CPI, core inflation is also published, which removes energy and fresh food because their prices rise and fall so much (storms, harvests, wars).

1. a) Explain what the core figure shows (the underlying trend of prices).
2. b) If the general CPI reads $5\ \%$ because of electricity and the core one $2\ \%$, explain what is really happening with most prices.

Not all prices rise at once or for everyone: one year oil and electricity rise by $15\ \%$ while mobile phones fall.

1. a) Explain why the 'official' inflation (the average) may not match the one your family suffers: it depends on what you spend on.
2. b) Think of a family that heats the house with diesel and another with solar panels: who feels that inflation more? What does this teach us when reading the CPI news?

Hyperinflation is runaway inflation, with prices rising every week or every day, like Germany's in $1923$ or Venezuela's a few years ago.

1. a) Explain what happens to money in that case (it stops being useful: people get rid of it as soon as they receive it and go back to barter).
2. b) Argue why households and firms can't plan anything with hyperinflation and why keeping inflation low and stable is a goal of the authorities.

A sandwich cost $5\ \text{€}$ a year ago and inflation has been $5\ \%$.

1. a) Calculate how much it costs today if it has increased at the average rate.
2. b) Your weekly pocket money is still $20\ \text{€}$: calculate how many sandwiches you could buy a year ago and how many now.
3. c) Use this result to explain what losing purchasing power means, even though "your pocket money hasn't gone down".

Iris's mother's salary was $1.500\ \text{€}$ per month. This year she received a $2\ \%$ pay rise, but inflation was $4\ \%$.

1. a) Calculate her new salary.
2. b) Calculate the salary she would need to maintain her purchasing power exactly (so she can afford the same as before) and how many euros short she is.
3. c) Has she gained or lost purchasing power? Explain the difference between getting a pay rise and the cost of living going up.

Deflation is a general fall in prices, and it is also a concern. Explain the chain of events: if people expect everything to be cheaper next month, they delay purchases; shops sell less; businesses make less profit and lay off workers; with higher unemployment, even less is bought. Illustrate this using a fictional local furniture shop in your neighbourhood.

The CPI basket weights each group according to its share of spending: housing and utilities $33\ \%$, food $25\ \%$, transport $15\ \%$, leisure $10\ \%$ and the rest $17\ \%$. This year these rise: housing $6\ \%$, food $4\ \%$, transport $2\ \%$, leisure $1\ \%$ and the rest $3\ \%$.

1. a) Calculate the weighted average inflation (multiply each rise by its weight and add up).
2. b) Explain why housing 'rules' so much in the CPI even though you don't pay it every week like the food shopping.

A kilo of chicken cost $6\ \text{€}$ at the start of $2024$. That year it rose by $4\ \%$ and in $2025$, by a further $3\ \%$.

1. a) Calculate the price after each rise (careful: the second one applies to the already risen price).
2. b) Calculate the total rise as a percentage relative to the initial price and explain why it is not exactly $4 + 3 = 7\ \%$.

The supermarket workers' collective agreement raises wages by $3\ \%$ and the year's inflation has been $5\ \%$. The average wage was $1.400\ \text{€}$.

1. a) Calculate the new wage.
2. b) Calculate what wage would be needed to avoid losing purchasing power and how many euros a month are lost.
3. c) Explain what the real wage is (the wage after discounting inflation) and why trade unions ask for CPI-linked review clauses.

The rent on Laia's family flat is reviewed every year with the CPI: they pay $650\ \text{€}$ and this year's CPI has been $2,1\ \%$.

1. a) Calculate the new monthly rent and the total rise in euros over the year.
2. b) Explain why contracts are updated with the CPI (so that the landlord doesn't lose purchasing power) and what debate opens up when inflation soars (who absorbs the blow: tenant or owner?).

In $2015$ the set menu at the café downstairs cost $9\ \text{€}$; today it costs $12,50\ \text{€}$.

1. a) Calculate the rise as a percentage over those years.
2. b) If the country's accumulated inflation in that period was $22\ \%$, compare: did the menu rise more or less than the average?
3. c) Give two reasons for the menu rising more (raw materials, wages and the rent of the premises) and explain what happens to the café if it doesn't raise prices when its costs rise.

In January, Lucía lent $10.000\ \text{€}$ to her brother at a fixed interest rate of $2\ \%$ per year to be repaid after one year, with both expecting an annual inflation rate of $2\ \%$. However, an economic shock causes inflation for that year to end up at $6\ \%$.

1. a) Calculate the real interest rate Lucía has obtained and interpret whether she has gained or lost purchasing power.
2. b) Determine how much money the brother should return at the end of the year so that Lucía maintains exactly the same purchasing power as the initial $10.000\ \text{€}$ had.
3. c) Explain with reasons who has benefited and who has been harmed in this transaction. What would have happened if the loan had been signed at a variable interest rate indexed to inflation (a real rate of $0\ \%$ plus CPI)?

Analyze the following two financial press headlines:

• Headline A: "The rise in the international price of natural gas and maritime shipping rates pushes up manufacturing costs for European industry."

• Headline B: "The extraordinary increase in direct aid and accumulated savings triggers a surge in travel and dining bookings, allowing hotels and restaurants to raise prices in the face of an avalanche of customers."

1. a) Classify each case with reasoned arguments according to the type of inflation (demand-pull or cost-push) and describe the mechanism through which prices end up rising in each headline.
2. b) Predict the effects of an aggressive interest rate hike by the European Central Bank if applied against the situation in Headline A: will it succeed in making imported gas cheaper? What impact will it have on economic activity and business employment? Justify why in this case the central bank faces a dilemma.

In a televised debate, a panelist argues: "The European Central Bank's goal of maintaining inflation around $2\ \%$ is detrimental to citizens; the ideal situation would be a continuous annual deflation of $2\ \%$, because that way money would be worth more each year and we would be richer."

1. a) Rebut the panelist's position by explaining the mechanism of the deflationary spiral: predict what would happen to households' consumption decisions and businesses' investment and hiring decisions if they knew for certain that prices will be lower next year.
2. b) Justify why central banks consider that moderate and predictable inflation (around $2\ \%$) is a sign of a healthy economy, distinguishing it from both deflation and runaway inflation.

At the beginning of the year, don Ernesto receives a retirement pension of $1.200\ \text{€}$ per month and the Rovira family earns a combined salary of $2.000\ \text{€}$ per month. Inflation over the course of the year turns out to be $5\ \%$. For the following year, the Government decides to increase pensions by $1,5\ \%$, while the Rovira family's collective bargaining agreement includes a wage guarantee clause that adjusts salaries to $100\ \%$ of the recorded CPI ($5\ \%$).

1. a) Calculate the new nominal income for don Ernesto and the Rovira family for the coming year, and determine the change in purchasing power (in percentage and in constant euros from the previous year) experienced by each.
2. b) Analyze the dilemma faced by the State if it decides to index by law all public pensions and salaries to the CPI in times of very high inflation: what effects does it have on social equity, and what consequences does it generate for the public deficit and inflation itself?
3. c) Propose and justify a fiscal policy measure that protects the purchasing power of low-income pensioners (such as don Ernesto) without compromising the balance of public accounts.

A group of neighbors indignantly states: "The price of a baguette has risen from $0,80\ \text{€}$ to $1,20\ \text{€}$ because the neighborhood bakeries are taking advantage of the situation to make twice as much profit."

1. a) Identify three production costs of a traditional bakery that increase directly during an energy and agricultural crisis, and explain how they are passed on to the final price without the baker's profit necessarily increasing.
2. b) If you had to audit the bakery's accounts to verify whether there has been an abusive increase in profit margins or a simple cost pass-through, design which two accounting indicators or ratios you would compare between the previous year and the current one.
3. c) Predict what economic consequences would occur in the neighborhood if the town council legally set a mandatory maximum price of $0,80\ \text{€}$ per baguette, in a scenario where producing it costs $0,95\ \text{€}$.

Spain imports the vast majority of the hydrocarbons it consumes. In an international context of war tensions, the price of a barrel of oil rises by $60\ \%$.

1. a) Describe the transmission chain that turns this external rise in crude oil into a widespread price increase in everyday consumer goods, such as vegetables or household cleaning products, justifying the concept of "imported inflation."
2. b) Critically evaluate why an interest rate hike by the central bank has very limited effectiveness in directly stopping this type of inflation, and what secondary economic costs it imposes on mortgaged households and businesses applying for loans.
3. c) Design two economic policy measures that a Government can adopt to cushion this impact: a short-term one aimed at the most vulnerable households, and a structural long-term one to reduce external dependence.

In an economy with an annual inflation rate of $7\ \%$, the works councils of the main productive sectors demand wage increases of at least $7\ \%$ to avoid losing purchasing power. At the same time, employers' organizations announce that if they take on this additional wage cost, they will increase the selling prices of their products by an equivalent percentage.

1. a) Draw up a cause-and-effect diagram demonstrating how this interaction triggers the so-called "wage-price spiral" (second-round effects), and explain why the initial inflation risks becoming chronic.
2. b) Predict how this spiral would affect the international competitiveness of the country's companies compared to competitors from other countries that keep their inflation under control.
3. c) Outline the basic framework of an "incomes pact" between employers, trade unions, and the Government: what reciprocal commitments or sacrifices should workers and business owners take on to curb the spiral by consensus?

A family allocates its monthly food budget as follows: $100\ \text{€}$ on fruit, $200\ \text{€}$ on beef, $50\ \text{€}$ on virgin olive oil, and $100\ \text{€}$ on white fish. After one year, prices have evolved unevenly: fruit rises by $10\ \%$, meat rises by $15\ \%$, olive oil rises by $40\ \%$, and white fish falls by $5\ \%$.

1. a) Calculate the monthly cost of the initial basket after the price increases if the family buys exactly the same kilograms as the previous year, and calculate the specific inflation rate for this family basket.
2. b) To curb spending, the family decides to substitute $50\ \%$ of its beef consumption with chicken (whose price is $50\ \%$ lower than that of the already more expensive beef) and substitutes half of the olive oil with sunflower oil (which costs one-third of the more expensive olive oil). Calculate the new monthly expenditure and determine whether they managed to reduce their spending below the initial budget of $450\ \text{€}$.
3. c) Based on this case, explain what the "substitution bias" of the official CPI consists of and why this index can overestimate the real impact of the cost of living on households when relative prices change sharply.