Defining inflation.

Inflation refers to the economic phenomenon where prices of goods and services tend to increase over time. This is caused by a decrease in supply, a decrease in the value of a currency, or an increase in demand. Inflation is measured as the rate of increase in prices of certain goods and services over time. For example an increase in the price of apples from $1.00 to $1.50 over the past year. 

Measuring inflation.

To measure inflation, the government uses equations such as the Consumer Price Index (CPI). This measurement indicates the percentage change in the price of a basket of goods and services commonly purchased by households.

The basket of goods usually represents common items used by consumers, such as gas, housing, transportation, food, and medical costs. The Consumer Price Index is calculated over a specific period, such as a month or a year, and is expressed as a percentage.

A healthy inflation rate for the economy is considered to be 2% or under. Other metrics used by policymakers, economists, and businesses to monitor inflation rates include the Producer Price Index (PPI), Gross Domestic Product (GDP) Deflator, and Employment Cost Index (ECI).

The significance of inflation

If inflation rates go up, your purchasing power goes down. In most cases, the value of the currency goes down. So, if your paycheck stays the same but prices increase, you are not able to afford goods and services that you might regularly use, putting you at a disadvantage.

For example, if you normally spend $600 on groceries per month, but because of inflation, groceries increase to $750, you need to work extra hours to cover the expense, or make more money, which is not possible for everyone. 

Effects of inflation on the economy.

Reduction in purchasing power: When inflation rises, the value of our currency decreases, which means that we are not able to buy as many goods and services for the same amount of money. This reduction in purchasing power can lead to reduced consumer spending and slow down the economy.

For example, if you previously had $500 left over from each paycheck to spend on entertainment, but due to inflation that amount decreases, you may have to allocate more money towards bills and necessities, leading to a decrease in consumer spending on non-essential items. This can cause the economy to slow down because there aren’t as many people willing to buy products or services.

Rising rates: To slow down inflation, the Federal Reserve may increase its interest rates, which can have a significant effect on borrowing, lending, and investments. When inflation increases, interest rates typically follow, making it much more expensive to borrow money.

This can slow down investors, causing a decrease in jobs. Additionally, higher interest rates will increase your monthly payments, leading to a decrease in the number of loans handed out to consumers because they may not be able to afford the payments.

Hurt some individual’s income: When inflation occurs, it can hurt certain individuals, such as those on fixed incomes, social security, and disability. Even though they may receive an increase in their monthly amount, in most cases it is not enough to compensate for the inflation rate, making it difficult for them to cover their cost of living.

Additionally, inflation can have another effect, where businesses can increase the prices they charge for their goods due to limited supply, allowing them to make a larger income even if the product did not cost them more to produce. We saw this happen with used car prices. 

Reduction of value of debt: As crazy as it might sound when inflation happens there is sometimes a reduction in the value of debt.

This usually means that the amount you borrowed is worth less now because the value of money has decreased making it easier for you to repay the debt. 

Increase in cost: Prices of raw materials, labor, and other production inputs can increase. This can lead businesses to increase the cost of their services or products to help maintain their profit margins and keep their business running.

However, this can also decrease the number of people buying products, which can slow down the economy. For example, if you used to buy a soda for $1 every day, but now it costs $5, you will likely decrease the number of sodas you purchase. This reduction in sales can hurt the economy by lowering the number of products sold.

Decrease savings: Savings can have a significant impact due to inflation, as the amount of money you have may now be able to buy fewer goods or services than before.

For example, let’s say you have $10,000 in your account, and you can buy five pairs of shoes for $2,000. But due to inflation, the price of the shoes goes up to $3,000, meaning you are only able to purchase three pairs of shoes. This means that the buying power of your savings account has decreased.