Inflation is a continuous rise in the general price level of goods and services over a period of time in a particular economy. It doesn’t consider as a good sign as it indicates an increase in the cost of living and a decrease in the purchasing power of the general public. It reduces the value of the currency of a particular country which simply means your money won’t be able to buy as many goods and services now as it could before.
Inflation rate – It is a percentage increase or decrease in a price level of goods and services over a specific period of time.
How does inflation affect our life? Let us understand it with an example.
Suppose you want to celebrate your next birthday in a lavish hotel so you enquire the manager of that hotel about the cost and it is around Rs.1 lakh for the whole arrangement, but he doesn’t guarantee the same price for next year. So you decide to have a backup and arrange some extra money for your party. Let us take, you arrange an extra Rs. 5000 for your party. Now after a year, inflation hits at 10% which means the general price level of goods and services increases by 10%. Now the birthday party you were planning will cost you Rs. 1 lakh + 10,000 instead of Rs. 1 lakh due to a 10% increase in inflation. As you have already arranged Rs. 5000 in advance now you have to arrange extra Rs. 5000 to compensate for the inflated price. This case implies how your money lost its value or how your Rs. 1 lakh are not enough now for your birthday party, which were last year.
What are the causes of inflation?
1. Demand-pull inflation
In this case, demand increases but supply remains the same. It occurs when demand for goods and services exceeds its supply in the economy. There are many reasons due to which demand can increase, for example in a growing economy, better incomes (wage push inflation) often leads to a rise in demand for a better standard of living or asset inflation which is caused by the increase in demand of any asset, for example, gold, property, stock, etc.
Demand-pull inflation sometimes leads to hyperinflation in which prices of goods and services rises uncontrollably over a particular period of time. It is a rapid form of inflation which generally rises more than 50% a month. The money supply is an important factor which can pump hyperinflation, done by the government by printing or adding more money in the economy.
2. Cost-push inflation
In this supply decreases but the demand remains the same. It occurs when the supply of goods and services decreases and is unable to meet its demand. Now, this may have caused due to the increase in the price of inputs such as labour, raw material, etc, or high cost of production. For example, increase in labour cost creates cost-push inflation or unexpected damage caused by any natural calamity to production provision will cost high for a company to regenerate it and this could limit the supply for some time. High taxes imposed by the government also increases the cost of production for company or high prices of commodity and raw material used is another reason for the increase in this type of inflation. Monopoly also leads to cost-push inflation which is done just for profit generation by reducing the supply.