What is inflation, and why do prices go up?

Why does everything cost more?

Have you ever heard a grown-up say, "When I was your age, that only cost a dollar"? They are probably right. Over time, the prices of most things slowly creep up.

When prices rise across lots of the things people buy, such as food, rent, petrol, clothes and haircuts, it is called inflation. One thing getting dearer is not inflation on its own. Inflation is about the general level of prices across everything households spend money on.

Prices do not only go up. Sometimes they fall across the board, and that is called deflation. But usually, prices rise a little each year.

Pocket money maths

Imagine you get $10 of pocket money a week, and your favourite ice block costs $2.00. You can buy five of them.

Now imagine prices rise by 3 per cent over a year. The ice block now costs $2.06. Your $10 buys only four ice blocks, with $1.76 left over. Your money has not changed, but it buys less. We say its purchasing power has fallen.

Small rises add up. If prices kept rising by 3 per cent every year, that $2.00 ice block would cost about $2.69 after 10 years, and prices would roughly double in about 24 years.

Here is the formula for working out inflation: take the new price, subtract the old price, divide by the old price, then multiply by 100. For the ice block, ($2.06 − $2.00) ÷ $2.00 × 100 = 3 per cent. And if your pocket money rose by 5 per cent while prices rose by 3 per cent, you could buy about 2 per cent more than before.

A giant shopping basket

In Australia, inflation is measured by the Australian Bureau of Statistics (ABS) using the Consumer Price Index, or CPI. Think of the CPI as a giant imaginary shopping basket holding the goods and services that Australian households buy. The ABS tracks prices for thousands of items, sorted into 87 categories.

Things that families spend more on count for more in the basket. Every year, the ABS updates how much each item counts, as spending changes. It has also added new things, such as smartphones, as technology changed what people buy.

To fill in the basket, the ABS collects prices from supermarkets, department stores, websites, energy companies and real estate agents, around one million prices every three months. It publishes the CPI every month. In the 12 months to July 2026, the CPI rose by 3.5 per cent.

Why do prices rise?

The Reserve Bank of Australia groups the causes of inflation into three kinds. The first is when people and businesses want to buy more than can be made. Think of a toy that every kid wants for their birthday: if shops cannot get enough, its price can go up. When that happens across lots of goods and services at once, it is called demand-pull inflation.

The second is when it costs more to make things, for example because wages, fuel or ingredients get dearer. Businesses may pass those costs on in higher prices. This is cost-push inflation. The third is expectations: if everyone expects prices to rise, businesses may raise prices and workers may ask for bigger pay rises, which can push prices up.

The 2 to 3 per cent target

The Reserve Bank of Australia (RBA) is the country's central bank. Its target is to keep inflation between 2 and 3 per cent a year, aiming for the middle of that range.

Why not zero? If inflation is too high, money loses its value quickly, and people struggle if their pay does not keep up. If prices start falling, people may put off buying things while they wait for lower prices. Then businesses sell less and may cut jobs. Low and steady inflation, which the RBA calls price stability, helps the economy grow.

One of the RBA's main tools is the cash rate, an interest rate that affects the cost of borrowing money. If inflation stays too high, the RBA usually raises the cash rate. Borrowing becomes more expensive, people and businesses tend to spend less, and price rises slow down. If inflation is too low, it can lower the cash rate.

📚 Words to know

Inflation

A general rise in the prices of the goods and services people buy, over time.

Deflation

A general fall in prices over time.

Purchasing power

How much you can buy with an amount of money. Inflation makes it shrink.

Consumer Price Index (CPI)

Australia's main measure of inflation. It tracks the prices of a basket of things households buy.

Cash rate

An interest rate set by the Reserve Bank that affects how much it costs to borrow money.

🧪 Try this: make your own price index

1. With a grown-up, find an old supermarket receipt or catalogue from at least a year ago.
2. Choose five items on it. Write down each old price, then find today's price for the same item (on your next shop or on a supermarket website).
3. For each item, work out (new price − old price) ÷ old price × 100. That is its price change in per cent. Which item went up the most? Did any go down?
4. Add up your five answers and divide by five to get your own mini price index. The ABS does the same thing, but with thousands of items, and things families spend more on count for more.
5. Bonus: with a grown-up, try the RBA's inflation calculator to see what $10 in the year they were born would equal today.