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Inflation
Inflation is defined as a sustained increase
in the general level of prices for goods and services.
It is measured as an annual percentage increase. As
inflation rises, every dollar you own buys a smaller
percentage of a good or service.
The value of a dollar does not stay constant when
there is inflation. The value of a dollar is observed
in terms of purchasing power, which is the real,
tangible goods that money can buy. When inflation goes
up, there is a decline in the purchasing power of
money. For example, if the inflation rate is 2%
annually, then theoretically a $1 pack of gum will
cost $1.02 in a year. After inflation, your dollar
can't buy the same goods it could beforehand.
There are several variations on inflation: Deflation
is when the general level of prices is falling. This
is the opposite of inflation. Hyperinflation is
unusually rapid inflation. In extreme cases, this can
lead to the breakdown of a nation's monetary system.
One of the most notable examples of hyperinflation
occurred in Germany in 1923, when prices rose 2,500%
in one month! Stagflation is the combination of high
unemployment and economic stagnation with inflation.
This happened in industrialized countries during the
1970s, when a bad economy was combined with OPEC
raising oil prices.
In recent years, most developed countries have
attempted to sustain an inflation rate of between
2-3%.
Causes of Inflation
Economists wake up in the morning hoping for a chance
to debate the causes of inflation. There is no one
cause that's universally agreed upon, but at least two
theories are generally accepted:
Demand-Pull Inflation - This theory
can be summarized as "too much money chasing too
few goods." In other words, if demand is growing
faster than supply, then prices will increase. This
usually occurs in growing economies.
Cost-Push Inflation - When companies'
costs go up, they need to increase prices to maintain
their profit margins. Increased costs can include
things such as wages, taxes, or increased costs of
imports.
Costs of Inflation
Almost everyone thinks inflation is evil, but it isn't
necessarily so. Inflation affects different people in
different ways. It also depends on whether inflation
is anticipated or unanticipated. If the inflation rate
corresponds to what the majority of people are
expecting (anticipated inflation), then we can
compensate and the cost isn't high. For example, banks
can vary their interest rates and workers can
negotiate contracts that include automatic wage hikes
as the price level goes up.
Problems arise when there is unanticipated
inflation:
Creditors lose and debtors gain if the lender does not
anticipate inflation correctly. For those who borrow,
this is similar to getting an interest-free loan.
Uncertainty about what will happen next makes
corporations and consumers less likely to spend. This
hurts economic output in the long run. People living
off a fixed-income, such as retirees, see a decline in
their purchasing power and, consequently, their
standard of living. The entire economy must absorb
repricing costs ("menu costs") as price
lists, labels, menus and more have to be updated. If
the inflation rate is greater than that of other
countries, domestic products become less competitive.
People like to complain about prices going up, but
they often ignore the fact that wages should be rising
as well. The question shouldn't be whether inflation
is rising, but whether it's rising at a quicker pace
than your wages.
Finally, inflation is a sign that an economy is
growing. In some situations, little inflation (or even
deflation) can be just as bad as high inflation. The
lack of inflation may be an indication that the
economy is weakening. As you can see, it's not so easy
to label inflation as either good or bad -- it depends
on the overall economy as well as your personal
situation.
By aboutdinar.com
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