Inflation 101: The Basics, Explained Simply
Ever wondered why the same cup of morning coffee costs more every year? The same coffee? From the exact same company? Well, that is because of an macroeconomics phenomenon known as Inflation.
What is Inflation
By definition, Inflation is a sustained, persistent increase in the general price level of goods and services in an economy over a period of time In simple terms, Inflation is the rise in prices of good and services over time.
When the prices of goods or services increase, the value of money decreases, i.e we buy less of goods for the same amount of money. This decreases our purchasing power. Purchasing power is the amount of goods that a value of money can actually
For example:
A notebook costs 100 today. With 5% inflation, next year it costs 105. The prices of notebook increased because of Inflation.
Even though you have the same 100, it can no longer buy the notebook. Thus, the 100 now buys less than before.
What Causes Inflation
The major causes of inflation can be classified into two types:
Demand-Pull Inflation
Cost-Pull inflation
Demand-Pull Inflation: This happens when aggregate demand for goods and services exceeds aggregate supply (demand>supply). When demand exceeds supply, prices rise.
Reasons for this can be economic growth, increase in government expenditure, increased consumer spending, etc.
For example: Many want to buy the premium cars and bags therefore the prices of such goods increases
Cost-Push Inflation: This happens when cost of production increases forcing producers to increase prices to maintain profit
Reasons for this can be increase in cost of raw materials, wages, etc
For example: If price of milk increase, prices of coffee increases, because both are complementary goods.
How Inflation Affects Us
Purchasing Power: As people can buy lesser goods for the same amount of money, the purchasing power decreases.
Savings: Inflation decreases the value of savings as the money you saved can now buy less than before
Income Groups: Inflation has different effects on different income groups.
• Fixed Income groups (salaried employees) suffer because in their income remains same while prices rise Thus, they can buy less than before.
• Business Owners may benefit of inflation as charging more price leads to higher profits.
Conclusion
Inflation is a maior macroeconomic problem as it affects real value of money, especially for fixed income groups as it reduces purchasing power and affects economic stability. Early awareness and smart financial choices are critical.
Stay informed save smart to let your money brew growth over time.
Written by Alisha Nasim. Image from Pinterest.
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