What is Inflation? A Complete Guide to Causes, Effects, and Measurement

(5/5, 2 votes)

Inflation is the economic phenomenon at which the usual level of prices for services and commodities rises constantly; consequently, the overall value (purchasing power) of the currency continues to fall.

Understand inflation in Daily Life

We keep hearing things that market rates of fruits and vegetables are raising, that the happy meal that we purchased last month from McDonald’s is now 25% pricier or that there’s an increase in the gas prices every other day at the gas station. The rise in prices sometimes doesn’t bother us at all when it’s an insignificant increase but it turns out to be a severe toothache if the rates are highly increased. This increase in the prices of goods and services is referred to as inflation.

Inflation and Purchasing Power

Inflation is determined when there’s a decrease in our purchasing power. For example, if that $5 bill in our wallet isn’t sufficient to get us the list of things that we could once purchase with the same amount, then the purchasing power of our money is said to have declined and we’re said to have encountered inflation. If the gum that was worth a dollar yesterday is now worth $1.5, then this slight rise is also inflation.

Causes of Inflation

Now that we know what inflation is, let’s find out what causes it. Why do the commodity prices rise? Why do our salaries increase? Why sometimes the increase in our salaries isn’t much of good news when there’s inflation out there? There’re a number of theories that will help us in finding the answers.

Cost-push Inflation- One of the most common reasons for inflation is when the cost of goods and services ascend due to the increased wages, cost of raw materials, taxes etc. The overall expenditure increases resulting in an increase in prices.
Demand-pull Inflation- When the demand rises abnormally so much so that the supply isn’t enough to meet the demand, then the prices are increased. The demand pull inflation is a positive sign that an economy shows pertaining to its growth.
Monetary Inflation- When in an economy there’s an overflow of money, the prices are increased. Just like value of goods and services decreases when their supply increases, the value of money also declines with its oversupply.

Inflation may sound like a negative thing for the masses in general but it actually impacts positively as well. It’s not much of a problem when it’s the anticipated kind of inflation. Anticipated inflation is the one of which the people are aware of in advance. For example, where a company increases its interest rates, it notifies the employees beforehand so that they’re mentally prepared about the raise and they have the option to request the salary increase or other benefits in compensation.

Inflation Themed Variations

Several other inflation-like economic conditions are as follows:

A similar condition which works exactly contrary to inflation is called deflation. The prices of the goods and services in this situation tend to decline. This normally occurs during the periods of economic depression or recession.

Then there’s disinflation in which inflation stays but its rate gradually declines. For example, price of an article, say potatoes is yet increasing but the increase is not as fast as it was before; $2 increase a month has now become a dollar increase per month and the rate tends to decrease further.

Hyperinflation is another economic condition in which there’s a super normal increase in the product rates. The rise in prices goes as up as 50% a month. Germany encountered hyperinflation in 1923 with an increase in prices up to 2500% a month.

The last variation of inflation is stagflation. It is a mix of economic stagnation and unemployment, which are present along with persistent inflation. This type is really bad and capable of completely shattering the economy.

Interesting Facts about Inflation:

In 1950, the purchasing power of 1 dollar was the same as 11 dollars in 2018.
US dollar inflated 21% in the last decade. For instance, if you could buy a burger with $1 in the last decade, you will need $1.21 to buy that same burger.
War always causes rapid inflation.
28 hyper-inflations occurred in the 20th century around the world and 20 of them occurred after 1980.
Runaway inflation was one of the major causes of the fall of the Roman Empire.
Gold currency has proved to cause little or no inflation at all. Sometimes it caused deflation.