Inflation
Inflation is a sustained rise in prices over time. It causes the value of money (purchasing power) to decline.
Inflation is expressed as a percentage change.
Ex. – If a can of soda cost 75¢ last year, and now costs $1, the inflation rate (for a can of soda) was approximately 33%
(.25/.75 = .33 x 100 = 33%)
Economists use the Consumer Price Index (CPI) to track inflation. The CPI is a market basket (sample) of goods and services whose current prices are compared to their base year prices.
Causes of Inflation
Rising input costs - labor, oil, etc. (Cost Push) – if businesses’ costs rise, they are forced to raise their prices to keep making a profit.
Wage/price spiral – wages rise, which causes prices to rise, which in turn causes wages to rise more, and so on…
Demand pull – high demand (from consumers, business, government) leads to shortages, which leads to higher prices.
Monetary growth (Quantity Theory) – when the money supply increases faster than real GDP, prices tend to rise.
Consequences of Inflation
The dollar buys less – especially tough on people with fixed incomes.
Planning for business becomes difficult if costs/prices aren’t stable. This is very bad for businesses – they tend not to invest – which means less jobs, growth, etc. Consumers also tend to spend less if they’re unsure of the future, which often leads to recession
Inflation hurts lenders – if I lend you $100 during a time of inflation, when you pay back the money after some time, it will be worth less than the original $100 I loaned out. Thus, people don’t want to lend out money. When people can’t borrow money for spending and investment, the economy slows down.
Hyperinflation – inflation of 500% or more.