Inflation

 Inflation Threat to Economic Growth

Inflation is the rate of increase in prices of goods and services within a specified period. Inflation is the change in value of goods and services, and a change in prices is common in the market economy, some prices rise, some prices fall. But if there is a change in prices on the broad level, then it is called inflation.

Inflation, the value of your money and purchasing power, decreases over time. To live a healthy life, we need a set of products and services, such as commodities like food grains, metal, fuel, utilities like electricity, and transportation, and services like healthcare, entertainment, and labor.

Deflation is the opposite of inflation, in which prices decline and purchasing power increases.

Types of Inflation

We categorized inflation into four forms: demand-pull inflation, cost-push inflation, saturated inflation, and monetary inflation.

Demand-Pull Inflation:

When the money supply is increased in the market, and people's demand for goods and services is also increased, then economic production capacity is increased, leading to a gap between demand and supply. Due to a lower supply price of goods and services, prices rise. The supply of goods and services does not meet the demand, so it creates demand-pull inflation.

Cost-Push Inflation:

This type of inflation is caused by an increase in the cost of important goods or services, which have no suitable alternative. Sometimes the cost of production is increased due to a rise in wages and raw materials. In which demand for goods does not change, the aggregate supply can decrease due to a higher cost of production. The prices increase from production passes to the consumers, which is cost-push inflation.

For example, production employees want to increase their wages, and management agrees to it, leading to a rise in the final price of the product.

Structural Inflation:

It occurs when there is an imbalance between the number of goods and services produced and the number of people who want to buy them. Due to this imbalanced behavior, the prices of goods and services rise. Businesses in sectors affected by structural inflation may see rising input costs (such as raw materials or labor). If these costs can't be passed on to consumers, businesses may have to cut back on production, reduce hiring, or even close their doors. On the other hand, companies with strong market power may be able to absorb higher costs without significantly affecting their profits, leading to inequality in how inflation impacts different businesses.

Monetary Inflation:

It can happen when the central bank prints more money or other banks make more loans. The additional circulation of cash raises the prices. Monetary inflation occurs when there’s an increase in the money supply in an economy, leading to a rise in prices of goods and services. But here's the key point: it’s not just more money that causes inflation, it’s the relationship between that increased money and the goods/services available in the economy.

When central banks lower interest rates, borrowing becomes cheaper. This leads to more money being injected into the economy, which can cause inflation if the supply of goods doesn’t keep up.

Types Of Price Index

A price index is a measure of change in the specified basket of goods and services within a specified period. Multiple types of baskets of goods are calculated and tracked as price indexes. The consumer price index(CPI) and the wholesale price index (WPI) are the most commonly used price indexes.

 

The Consumer Price Index:

The consumer price index(CPI) is an index number that examines the weighted average of prices of a basket of goods and services that are of primary consumer needs. The transportation, food, and medical care are included.

The Wholesale Price Index:

A wholesale price index measures the change in the overall price of goods before they are sold at retail. A WPI typically considers commodity prices, but the products included vary from country to country. Some small countries only compare the prices of 100 to 200 products, while larger ones tend to include thousands of products in their WPIs.

Measuring Inflation

These price indexes can be used to calculate the value of inflation between two particular months the year. There is a specific formula that is used to measure inflation.

 

   Percent Inflation Rate=(Final CPI index value/ Initial CPI value) 100

Advantages Of Inflation:

When people know that prices are likely to rise over time, they’re more inclined to spend or invest their money sooner rather than later. This can drive consumer demand and economic growth, as businesses respond by increasing production and hiring. People who have tangible assets (like property or stocks, commodities) priced in their home currency may like to see some inflation as that raises the prices of their assets, which they can sell at a higher rate.

In inflation, the value of money decreases over time. If you owe a fixed amount on a loan, the real value of that debt declines as inflation pushes up wages and prices. For example, if you took out a loan for $50,000 and inflation runs at 3% annually, that $50,000 becomes easier to pay off with each passing year, as your income (and potentially the value of your assets) rises. It’s easier for individuals and governments to manage debt because the real value of what they owe is eroded by inflation.

Inflation often leads to speculation by businesses in risky projects, in which people spend money on stocks and get benefits.

Disadvantages Of Inflation:

There are a lot of disadvantages of inflation, one of the most dangerous is that the value of a currency decreases, which impacts the whole economy. People need more money to satisfy their needs, and it creates difficulties for people to have a free and healthy life.

Inflation hurts people's purchasing power, and people can not maintain their lifestyle because they can not buy goods and services as they did before inflation. Low-income families have experienced struggling conditions due to their lower purchasing power.

Inflation can create an unstable economic environment. Businesses might be less willing to invest or make long-term plans because they are uncertain about future costs and demand. Central banks may raise interest rates to combat inflation. Due to this, borrowing becomes more expensive for businesses and consumers.

If inflation gets too high or remains persistent, it can lead to widespread dissatisfaction among the public, especially if wages aren't keeping up with price increases.

Causes Of Inflation:

Common causes of inflation are;

• Devaluation
• Monetary and Fiscal Policy
• People have more money to buy, but sellers are not prepared to fulfill the demand 
• Rising wages
• The cost of raw materials rises

How to control inflation:

Every government has two ways to control inflation;

Monetary policy can be used to manage inflation through the use of tools such as the money supply or interest rates to reduce the amount of money in circulation, which can reduce demand and slow the rate of inflation.

Fiscal policy is one of the major important tools and can be used to reduce demand in the economy by increasing taxes, reducing government spending, or raising interest rates.

Conclusion:

In conclusion, inflation is a complex economic phenomenon with both positive and negative effects. While a moderate level of inflation is often necessary for economic growth, as it encourages spending and investment, excessive inflation can have significant drawbacks. These include a decrease in purchasing power, increased uncertainty, erosion of savings, and greater income inequality. High inflation can also disrupt business planning, distort price signals, and lead to higher costs of living, which may ultimately harm economic stability.

Inflation is the result of an imbalance between supply and demand in the economy. This imbalance raises prices faster than the increase in wages, which can lead to a decrease in people's purchasing power. Inflation greatly affects the economy, with higher costs of goods and services, increased unemployment, and slow economic growth.

Related Topic: Elasticity of Demand