Skip to content

What Is Inflation?

what is inflation

Definition of Inflation

  • In simple terms, inflation is when the prices of goods and services increase over time.
  • While the prices of goods and services increase, the purchasing power or value of money decreases.

What Impacts Inflation?

  • The two main things that can impact inflation are the wages people receive and the prices of raw materials.
  • When wages increase, we experience inflation; when the prices of raw materials go up, we experience inflation. This movement is called cost-push inflation.
  • Demand-pull inflation occurs when there is a strong demand on the consumer’s end.
  • If there is a very high demand and the supply levels aren’t matched, prices go up hence causing inflation.

How to Calculate Inflation?

[(final CPI index value – initial CPI value) ÷ initial CPI value] * 100

  • CPI is known as the consumer pricing index, which measures the changes in prices based on a weighted average market basket of goods and services.

Why is Inflation Important?

  • Inflation works as a motivating factor to utilize any labor or resources that are not optimized to full potential.
  • Inflation also helps avoid the paradox of thrift, which claims that if prices fall consecutively, then people will wait and look for better deals.
  • If people are constantly waiting for better deals, then the aggregate demand will fall, reducing production and economic productivity.
  • Inflation is also vital for people who have taken out loans. This is because the money borrowed becomes less valuable over time and becomes easier to payback.
  • Therefore inflation is crucial as it pushes people to borrow money.

Inflation in Practice

  • For example, if one gallon of petrol costs $1.50 in 2000 and one gallon of petrol now costs $2.5, then how would you calculate the inflation?
  • 2.5 – 1.5 = 1 -> 1/1.5 = 0.67 -> 0.67*100 = 6.7% therefore, the inflation went up by 6.7%.