Inflation

Zimbabwe is one country that has faced the serious affects of inflation within an economy. At one point in time, a supermarket near the country's capital was selling a single, two-ply sheet of toilet paper for $417. For many of it's citizens, daily needs such as toilet paper, bread, margarine, meat and their morning tea had become unreachable luxuries.

As previously discussed with measures of instability, changes in price can be equally disruptive to the economy. When the general level of prices of goods and services rise, inflation occurs within the economy. On the opposite end, a decrease in the general level of prices for goods and services , this is called deflation. Neither situation is positive one, and need to be avoided in order to protect the economy.

To fully understand inflation, we must first identify the proper means of measuring inflation. There must be the construction of a price index, which is a statistical series used to measure changes in the price level over time. More specifically, economists use the consumer price index(CPI) - series used to measure price changes for a representative sample of frequently used consumer items. To construct the price index, the following steps must take place:

1. Select a Market Basket - a representative selection of commonly used goods and services. The CPI uses the price of about 364 goods and services, and these items are scientifically selected to represent the types of purchases that most consumers make.
2. Find the average price of each item in the market basket. The U.S. Census Bureau makes a monthly selection of 80,000 items in stores across the country and add up the prices to find the total cost of the market basket.
3. Establish a Base Year - a year that serves as the basis of comparison for all other years. Currently, the most popular used base year for average prices is from 1982-1984. To avoid confusion, this base year is changed very infrequently.
4. Finally, convert the dollar cost of a market basket into an index value. To do this, divide the cost of every market basket by the base-year market basket cost.

To then actually measure inflation, which is the change in monthly price level, you would measure the percentage change. For example, if the CPI changed to 199.9 from 190.4 one year earlier, you would take the difference between the two, and then divide by the 190.4, or the previous CPI. This would give rate of inflation of 5% for the 12-month period.

Economists describe the rate in which inflation changes in three different ways. First, creeping inflation can be used to describe a low rate of inflation, which is about 1 to 3 percent annually. Inflation at this low state usually is not seen as a problem. On the other end, hyperinflation is a term used to describe inflation that has gotten out of control. Hyperinflation is when there is an inflation in excess of 500 percent per year. This does not happen often, but when it does it is generally the last state before a total monetary collapse. Finally, economists use the term of stagnation to identify a period of slow economic growth paired with inflation.

• Nearly every period of inflation is due to one or more of its main causes. Whenever we as consumers have wanted something so badly that we don't even care about the price, is one example of how our behavior can actually fuel inflation. The following four situations listed are all main causes of inflation:
1. Demand-Pull Inflation: all sectors in the economy try to buy more goods and services than the economy can produce. Whenever consumers, business and the government increase their spending at stores, they cause shortages, which will drive up prices - prices are "pulled" by excessive demand. This is seen in many cases when consumers decide to use their credit cards, and go into massive debt buying things they normally could not afford.
2. Cost-Push Inflation: rising input costs drive up the price of production. This is seen most with input costs related to energy and organized labor. Within the labor union, whenever a strong national union wins a large wage contract, it then causes manufacturers to raise their prices to recover from the increased labor costs.
3. Wage-price spiral is a more neutral explanation as it does not blame any particular group or even for rising prices. However, self-perpetuating spiral of wages and prices becomes difficult to stop. This could happen when higher prices causes employees to ask for higher wages, which this causes produces to recover from those costs with higher prices.
4. Excessive monetary growth is the most popular explanation for inflation. This is when money supply grows faster than GDP. Any extra money or credit created by the Fed will increase someone's purchasing power, and when these people spend this extra money, they cause a demand-pull effect that drives up prices.

If inflation gets too high, it can absolutely have a disruptive effect on the economy. It can reduce purchasing power, where the dollar buys less as prices rise. The dollar then loses value over time. This is especially hard on retired people or those with a fixed income because their money buys a little less each month. Inflation can also cause distorted spending patterns where people change their spending habits. Back in the early 1980's, prices when up, causing interest rates to go up as well. This then caused consumers to spend dramatically less on durable goods such as housing and automobiles. Lastly, inflation can also tempt people to speculate in an attempt to take advantage of rising prices. From 2001 to 2005, interest rates were incredibly low, causing unqualified buyers to purchase high-priced homes. When interest rates went back up in 2006-2007, these buyers defaulted on their mortgage payments, which then helped drive the economy into recession.

Article from notes:

• US Inflation Remains Low, and That's a Problem

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Sources

• https://www.investopedia.com/ask/answers/061515/what-are-some-historic-examples-hyperinflation.asp
• https://www.economist.com/blogs/economist-explains/2015/01/economist-explains-4