- Inflation measures the rate at which the price level of an average basket of goods and services increase over a period of time in an economy.
- Rising prices result in the country’s currency losing value as it now buys fewer goods and services which in turns results in decreasing purchasing power of an average consumer.
- Factors that result in inflation include Demand-Pull Inflation, Cost -Push Inflation and Built-in Inflation.
What is Inflation?
Inflation measures the rate at which the price level of an average basket of goods and services increase over a period of time in an economy. Since rising prices result in a unit of currency buying less, inflation thus describes the decreasing purchasing power of a country’s currency. It is often expressed in percentage. When prices decreased, inflation is contrasted with deflation.
Rising prices result in the country’s currency losing value as it now buys fewer goods and services which in turns results in decreasing purchasing power of an average consumer. Because of this, cost of living of an average person is impacted, which ultimately results in decrease in economic growth of the country. Common consensus amongst economists is that inflation occurs when a country’s supply of money is greater than its economic growth. To manage this, it is the government’s job or the country’s financial institutions to ensure that inflation is kept within manageable limits to ensure that the economy runs smoothly.
To put simply, rising prices are considered to be the cause of inflation. However, there are different factors which include:
- Demand-Pull Inflation
This happens when the demand for goods and services in an economy is greater than the economy’s own production capacity. This results in a gap in demand and supply which in turn results in higher prices and thus, inflation.
In addition to this, increase in money supply also leads to inflation. As more money is available, there is an increase in spending. As a result, demand increase and along with it, the prices. Money supply is increased either by printing more of it, or it just being given away to individual or by devaluing the currency. Because of this, money then loses its purchasing power.
- Cost -Push Inflation
This occurs when the prices of production process inputs increase such as labor costs, cost of raw materials. These result in a cost of finished goods to be high as well, thus contributing to inflation.
- Built-in Inflation
With increase in prices of goods and services, cost of labor demands also increase to maintain their cost of living. Increased wages result in higher cost of goods and services which in turn induces increasing cost of living standards and the cycle continues.