What is inflation?
The word "inflation" means that the prices of most of the services, goods, and products that we use daily are on the rise. For example clothing, food, transport, PC, washing machine drinks, etc. A lot of people don't know what is true inflation meaning so that is why we gathered information and put them all in this one article.
Inflation is typically a broad measure and that means that it considers the overall increases in the prices.
Inflation is mainly measured by two indices: The first one is called WPI or also known as the Wholesale Price Index and the second one is CPI or also known as the Consumer Price Index.
The CPI mainly calculates the difference in the price of the services and products, for example, education, food, medical care, etc.
And the WPI mainly captures the services that are sold from businesses to other smaller businesses.
What is inflation in economics?
In the economic world, inflation represents the increase in the general price level. And that means there will be a decline in the value of the money (To break it out even more simple, the money won't buy you as much stuff today).
So when this inflation happens in a country then the country authority most likely the central bank takes all the measures and procedures to keep the inflation within the normal limits so that can allow the economy to continue running smoothly without huge notices on the prices.
What Causes Inflation?
So we have already discussed that inflation means that the prices are rising and there can be various factors that could be the reason for this. But inflation is mainly classified into 3 parts:
- Cost-push inflation;
- Demand-pull inflation;
- Build-in inflation.
This type of inflation begins when the demand for the services and products increases and it overtakes the production capabilities of the businesses. And when there is a lower supply but a higher demand, it leads to the business increasing the prices so that they can lower the huge demand.
The most obvious example of this is when the oil supply decreases and the demand are still the same, so there will be a rise in the prices of the oil.
Also if there is a lot of money available for almost all individuals then they would be able to spend higher. And by spending, higher this will decrease the supply. By decreasing the supplies will lead to increasing the prices and the money loses its purchasing power.
This type of inflation is mainly a result of higher prices for the production of a product or service.
This is quite different from the demand-pull inflation because this occurs when the demand is growing rapidly and the supplies can't fulfill them all.
This can cause economic disaster and the standards for a living will fall deep. But what is important to mention is that this inflation is temporary.
The most basic reasons for the cost-push inflation are:
1. Rising oil prices - If the oil industry sees a lot of oil demand, then that will lead to higher petrol prices as well as transportation costs. This could also lead to a cost-push type of inflation.
2. Higher direct taxes - IIf the VAT is higher than normally the prices for the services and goods will rise. But this is all temporary.
3. Higher food prices - This is also quite a big role in cost-push inflation.
If the prices for the services and goods rise then the businesses will have a harder chance to maintain their living costs. So that is why they would need to increase their wage to continue working as normal.
How to calculate the inflation rate?
As we mentioned the inflation rate can be calculated through the inflation indexes. 2 inflation indexes are most used: CPI and WPI.
CPI (Consumer Price Index)
The CI is a measurement index that will declare the average prices of the most essential goods and services that the consumer has on a daily basis. (food, oil, drinks, medical, etc.)
This method works in a way where you take all the price changes of all these essential items and services and then you average them based on all the other ones.
The changes of the CPI are associated with the living cost and this is the most commonly used price index for inflation.
WPI (Wholesale Price Index)
This is the second most popular measure of inflation and this tracks the changes in the prices of the goods that are used in the business to create the final product. So if the final products are made out of metal then this will include all the metal objects that are used in creating a final product.
A pretty similar price index that other countries use is PPI (producer price index).
The formula for measuring inflation
So to use the above-mentioned inflation indexes you have to get them into a formula. While there are a lot of ready inflation calculators available online, it is the best and safest way to calculate it by yourself. So here is the formula, it is quite easy and doesn't require a lot of mathematical skills.
Change in Inflation = (Final CPI Value/Initial CPI Value)
What is the difference between inflation and deflation?
Even though they might seem to be the same word they aren't. A lot of the people are confusing them and they don't know what are the correct words to describe them.
So to break it down simple, inflation mainly happens when the prices of the goods or services rise. And on the other hand, deflation happens when the prices for these goods and services come to a decrease. The balance between these 2 conditions has to be steady. But they are quite delicate and the economy can quickly change between the 2 conditions in a flash.
Also, inflation is not seasonal and might be in the economy for a lot more time, and it affects various sectors of the economy.
How to control inflation?
The inflation is mainly controlled either by the Central Bank or the government.
So to control the inflation governments use wage and price controls so that they can fight back on the inflation move.
They can also go ahead and find a monetary policy to fight against inflation by simply reducing the money supply in the economy. This will reduce the demand in the economy and that will end up leading to lower growth and lower inflation.
The deflation is mainly here when there are economic recessions, which means that people have less spending capacity.
So inflation can be a good and bad thing at the same time. And this all depends on which side you are on.
So let's take an example: people who have assets want to see some inflation so that their assets will rise in value and they can sell them at a pretty high rate. Well, on the other side the buyers of these assets aren't pretty happy with inflation because they would need a lot more money.
Another example: people who are stacking their cash don't like inflation because it lowers the value of their cash.
Either bad or good, inflation impacts the economy in a pretty negative way. The businesses are afraid to do big investments, it prevents them from making clear choices, this will lead to unemployment, impacts the foreign exchange rates, etc.
In the end, inflation is a pretty bad thing, so that is why every country needs to control its economy to avoid inflation to happen in the first place. By using some of the measurements, governments will be able to control the economy and avoid having high inflation rates.