Published on September 1, 2020

What is Inflation


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What is Inflation

In economics, inflation is the rapid rise in the price of goods and services in a country. Inflation is measured by the inflation rate. High level of inflation(inflation rate >500 per cent) called hyperinflation. During inflation central bank of the country print more money.

Causes of Inflation

Inflation is directly related to money growth. In simple words when a country produces a fewer amount of goods and services in comparison to the nation’s money supply.

“Inflation is always and everywhere a monetary phenomenon.”

Milton Friedman (Economist)

Inflation is basically a macroeconomic problem. The money growth caused due to two reasons large government debt and the second one is short-term gains.

  • To pay off the debts the government increase the money supply. In 1923, after World War I German government increase its money supply to pay off the debts of countries and its worker which leads to high inflation (inflation rate greater than 30,000%).
  • Sometimes the government increase the money supply to achieve a short-term goal and boost the economy. As a result, inflation occurs.

Effects of Inflation

Inflation is a real threat to a county’s economy.

  • Increase in Price: There is a general increase in commodities and services throughout the country. Because the overall production was not increased as a comparison to the availability of money in the market.
  • Tax Distortion: Due to inflation there is a rise in the effective tax rate on capital income. People are less likely to invest money on businesses.
  • Interest Rate: Interest is an amount of money paid to the lender by the borrower in return to use their money in one year. Real interest rate is equal to the nominal interest rate minus the inflation rate. So when inflation increase borrowers have the advantage over the landers.
  • Unemployment: High inflation is directly proportional to the high unemployment rate.

How to Measure Inflation Rate

Inflation is measure through Consumer Price Index or CPI.

US_Inflation.png

Computing CPI

The CPI is the price of a “basket” of goods and services purchased by a consumer in the United States. For example, let you go to the movie theatre and you buy a ticket and popcorn at $5 and $2 respectively. So your basket price would be 5+ 2 = 7 dollars.

Customer Price index = (basket price /basket price in the base year) * 100

Computing Inflation Rate

Inflation rate is measured by percentage of change in CPI over a certain period of time.

Inflation Rate= (CPI of 2012 – CPI of 2013/CPI of 2012)*100

Conclusion

Inflation is not only a concern for the economist but also the common people. It often leads to the loss of value due to nominal changes in wages or prices as real changes. Moreover, there is uncertainty in the future price level of goods and services.


Bibliographical Sources:

  • PRINCIPLES OF MACROECONOMICS, SECOND EDITION, COPYRIGHT © 2018 DIRK MATEER & LEE COPPOCK, NORTON & COMPANY, INC.
  • THE ECONOMICS OF MONEY, BANKING, AND FINANCIAL MARKETS, ELEVENTH EDITION, COPYRIGHT © 2016 FREDERIC S. MISHKIN, PEARSON
  • MACROECONOMICS, GLOBAL EDITION, 7TH EDITION, BY OLIVIER BLANCHARD, COPYRIGHT 2017, ISBN 9781292160504


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