What Is Inflation?
Inflation is a gradual loss of purchasing power, reflected in a broad rise in prices for goods and services over time. It is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country.
The rate is calculated as the average price increase of goods and services over one year. High means that prices are increasing quickly, while low means that prices are increasing more slowly. It can be contrasted with deflation, which occurs when prices decline and purchasing power increases.
How Does Inflation Work ?
It occurs when the prices of goods and services increase over a long period of time. The amount of goods and services you can buy with a single unit of currency, to decrease. In short, it means that your money may not be able to buy as much today as it could in the past.
When it occurs, money loses its purchasing power. This can occurs across every sector or throughout an entire economy. When it takes hold, the expectation of itself can further sustain the devaluation of money. Workers may demand higher wages and businesses may charge higher prices, in anticipation of sustained . This in turn reinforces the factors that push prices up.
What Are The Types of Inflation ?
Increase in the cost of money supply,high raw materials cost,labour cost .
The main types of inflation can be grouped into different broad categories:
- Demand-Pull
- Cost-Push
- Inflation expectation
- Built-In
1. Demand-Pull :
Demand-pull arises when the total demand of goods and services increases to exceed the supply of goods and services. The excess demand puts upward pressure on prices across a broad range of goods and services and ultimately leads to an increase in inflation that is ‘pulls’ higher.
Demand-pull is in contrast with cost push, when price and wage increases are being transmitted from one sector to another. However, these can be considered as different aspects of an overall inflationary process—demand-pull explains how price inflation starts, and cost-push demonstrates why inflation once begun is so difficult to stop.
2. Cost-Push :
Cost-push occurs when the total supply of goods and services in the economy which (aggregate supply) falls. A fall in aggregate supply is often caused by an increase in the cost of production. If aggregate supply falls but aggregate demand remains same, there is upward pressure on prices and inflation “that is ‘pushed’ higher”.
Cost-push can also arise when the supply disruptions in specific industries – for example, due to unusual weather or natural disasters, there are major cyclones and floods that damage large volumes of agricultural produce and result in significant increases in the price of processed food and both takeaway and restaurant meals, resulting in temporary periods of higher inflation.
3. Inflation Expectation :
Inflation expectation is that what we are exactly predicting what will happen in the future. These are the beliefs that households and firms have about future price increases. They are important because expectations about future price increases can affect current economic decisions that can influence actual outcomes.
For example : If firms expect future to be higher and act on those beliefs, they may raise the prices of their goods and services at a faster rate. Similarly, if workers expect future to be higher, they may demand higher wages to make up for the expected loss of their purchasing power. These behaviours, sometimes called ‘inflation psychology’, can contribute to a higher rate of actual inflation so that expectations about become self-fulfilling.
4. Built-In Inflation :
Built-in inflation is related to adaptive expectations or the idea that people expect from the current inflation rates to continue in the future. As the price of goods and services rises, people may expect a continuous rise in the future at a similar rate.
As such, workers may demand more costs or wages to maintain their standard of living. The increase in wages result a higher cost of goods and services, and the wage price spiral continues as one factor induces the other and vice-versa.
How Inflation Can be Controll
Inflation can be controll by a contractionary monetary policy . It is one of the common method of managing inflation.The contractionary policy aims to reduce the supply of money within an economy by lowering the prices of bonds and rising interest rates. Thus, consumption falls, prices fall and inflation slows down.
Methods to Control :
The Central Bank and/or the government normally monitor inflation. Monetary policy is the key policy employed (changing interest rates). There are however several instruments to manage inflation in theory, including:
The Central Bank or the government of a country monitor the inflation. Monetary policy is the key policy of changing the interest rates. There are different instruments to manage it in theory . These are as follows :
1. Monetary policy : Monetary policy describes that the higher interest rate decrease the economy’s demand, resulting in lower economic growth and lower inflation.
2. Money supply management : The claim is that a near correlation exists between money supply and inflation, so regulating the money supply can control inflation.
3. Supply-side policies : Supply side policies aim to boost the economy’s productivity and efficiency, which puts downward pressure on long-term costs.
4. Fiscal Policy: A higher rate of income tax could reduce spending, demand, and inflationary pressures through fiscal policy.
How Inflation Measured ?
Inflation generally refers to an increase in prices of various goods and services over time. How to calculate the inflation rate, estimating the rate involves some straightforward steps:
- Subtract an item’s original cost from its present cost.
- Divide the result by the original cost.
- Multiply by 100.
The calculation will provide a general idea of how it impacts your spending power.
Statistical agencies measure by determining the current value of a “basket” of different goods and services consumed by households, referred to as a price index. To calculate the rate of over time, they compare the value of index over one period with that of another. Comparing one month with another gives a monthly rate , and the comparison from year to year gives an annual rate of inflation.
Advantages and Disadvantages of Inflation
Inflation can be both ‘god or bad’ depending upon which side we choose,and how rapidly the changes occur in it. So now we will discuss the advantage and disadvantage which are as follows :
Advantages :
- Higher Profits since producers can sell at higher prices .
- Better Investment Returns since investors and entrepreneurs receive incentives for investing in productive activities .
- Increase in Production .
- More Employment and Better Income .
- Shareholders can earn a good income.
- Companies book more profits and tend to share it with their shareholders via dividends .
- Benefits to Borrowers ‘The real value of the money returned is less than that of the money borrowed’ .
Disadvantages :
- Fixed-Income Groups experience a fall in income including salaried employees, pensioners, etc.
- Inequality in Income Distribution Increases in every sector.
- Upsets the Planning Process.
- Speculative Investment Increases.
- Harmful Effects on Capital Accumulation.
- Negative Impact on Export Income.
Is It Good or Bad?
Too much of any country is generally considered bad for an economy, while too little is also considered harmful. Many economists advocate for a middle ground of low to moderate, of around 2% per year.
Generally speaking about , higher harms savers because it erodes the purchasing power of the money they have saved; however, it can benefit for the borrowers because the adjusted value of their outstanding debts shrinks over time.
The Bottom Line :
Inflation means rise in prices, which results in the decline of purchasing power over time. It is natural and the U.S. government targets an annual rate is of 2%; however, it can be dangerous when it increases too much, too fast.
It makes items more expensive, especially if wages do not rise by the same levels . Additionally, erodes the value of some assets, especially cash. Governments and central banks seek to control it through monetary policy.
