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%.