When in general prices of goods & services have increased over a period that’s called Inflation. It is typically measured in percentage change in a price index, such as the Consumer Price Index (CPI) or the Producer Price Index (PPI).
Consumer Price Index:- CPI monitors the average prices of a basket of goods and services consumed by households.
Producer Price Index:- PPI Monitors the average prices of a basket of goods and services produced by businesses.
Let’s Take an example:-
In consumer basket 1 there are 3 Products, Bread, Egg & Apple
Year 2023 Year 2024
- Bread – 10/- Per Unit Bread- 12/ Per Unit
- Egg – 8/ Per Unit Egg- 10/ Per Unit
- Apple – 100/ Per KG Apple- 105/ Per KG
Total Basket Value – Rs. 118 Total Basket Value- Rs. 172
The total cost of the basket has increased by Rs.9, which means Prices have changed by 7.62% That’s called inflation in the consumer index. It’s just an example of original inflation calculated on a large sample of products & consumer baskets.
Factors that influence Inflation:
Inflation Due to High Demand Supply: This occurs when aggregate demand for goods and services exceeds aggregate supply, leading to a rise in prices of that goods & supply. Increased consumer spending, government stimulus, or low-interest rates can drive demand-pull inflation.
Cost-Push Inflation: Inflation is Caused by an increase in production costs, such as wages, raw materials, or energy prices. When businesses face higher costs, they may pass them on to consumers through higher prices, leading to cost-push inflation.
Built-In Inflation: Also known as wage-price inflation, built-in inflation occurs when workers and businesses expect prices to rise and adjust their behavior accordingly. For example, workers may demand higher wages to keep up with expected inflation, leading to a self-perpetuating cycle of rising prices and wages.
Due in Money Supply: Central banks play a crucial role in managing inflation through monetary policy. Such as lowering interest rates causes increases in the money supply, can stimulate spending, and potentially lead to inflation. On the opposite, lowering the monetary policies by increasing the interest rates aims to reduce inflationary pressures by tightening monetary conditions.
Positive & Negative Impacts of Inflation:
Positive Effects: Moderate inflation can contribute to economic growth by encouraging spending and investment, reducing the real burden of debt, and incentivizing businesses to invest in innovation and productivity improvements.
Negative Effects: High or unpredictable inflation can weaken the purchasing power of the public, reduce consumer and investor confidence, distort economic decision-making, redistribute income and wealth unevenly, and undermine the stability of financial markets.
Central banks and governments often aim to maintain price stability by targeting a specific inflation rate, typically around 2-4% in many developed economies, through various policy measures aimed at managing inflationary pressures.