Answer to Question #129900 in Economics of Enterprise for What is inflation

Question

What is inflation

Answer 1

Inflation

Inflation is defined as the rate at which prices of a given good and services increases over a period of time. Generally, inflation is considered to be a persistent increase in prices of given goods and services over a period of time usually a month. For example, if the price of 500g of bread is 5$ in January, 5.5$ in February, 5.7$ in March, and 6$ in April, then we can say that prices of bread are experiencing inflation.

 In a given economy, inflation is mostly determined by the consumer price index. This index measures the monthly changes in prices of a selected basket of a commodity over a given period of time. The report consumer price index and inflation are usually released at the end of every month.

Types of inflation

There are two main types of inflation;

a) Demand-pull inflation. This is caused by an increase in aggregate demand over aggregate supply. The increase in aggregate demand results from an increase in the money supply or an increase in the level of income or an increase in the level of expenditure. This problem is mostly associated with an increase in the employment level. As people get more money, their purchasing power increases hence increase in the aggregate demand. If the aggregate supply doesn’t correspond with an increase in the demand, then the economy will face demand-pull inflation.

b) Cost-push inflation Cost-push inflation is caused by a general increase in the cost of production and raw materials. High costs of production will lead to a decrease in the aggregate supply in the economy. Since the demand for goods didn’t change, the price increases from such cost of production are passed onto consumers thereby creating cost-push inflation.

Other forms of inflation include;

I.                  Wage push inflation-Increase in wages increases the costs for firms, and so these costs are passed onto consumers in the form of higher prices.

II.               Imported inflation-This is caused by the depreciation in the exchange rate. This depreciation leads to a high cost of import which leads to an increase in prices of commodities.

III.              Temporary factors-Temporary government measures such as an increase in indirect taxes increase the VAT of goods thereby leading to an increase in prices of commodities.