Macroeconomics/Money and Inflation

What is inflation?

Inflation can be defined as the increase in the overall level of prices. Whilst the price of individual goods or services may vary due to changes in supply and demand, production costs or technological progress, inflation refers to the increase in the price level as a whole or for a selection of goods and services (commonly referred to in economics as a basket of goods). The result of inflation is that the nominal amount of goods and services that a unit of currency can purchase (its purchasing power) declines over time.

Of course, there is, in theory, nothing which make inflation an inherent feature of our economies. In historical times there have been prolonged periods of deflation (where the overall level of prices falls) as well as hyperinflation and disinflation.

Examples 1) ..... The average price of a specific "basket" of goods and services today is 100. If one year later the average price of a "basket" containing the SAME goods and services will cost you 300, then the currency of your country is worth only 1/3 as much as a year ago as a result of inflation. As a result of inflation all the prices of the SAME goods and services have increased.

..... Inflation is stated as a percentage. Assume, for example, that inflation is steady, every year the same, at 2% per year. Then an item that costs now 100 would cost after 1 year 102, then in future years: 104.04 106.12 108.24 110.41 112.62 114.87 117.17 119.51 121.90 and so on.


2) ..... Labor or labour unions always want more and more money to "make ends meet", and so do most other people. The price of goods and services must cover all costs, including all involved salaries and wages. If the currency is worth less as a result of inflation, then all costs go up, and therefore all prices go up. But because prices go up, everybody wants a raise in wages/salary. Therefore the costs go up again, the prices go up some more, and so on and so on. THAT is the unfortunate result of the inflation "spiral".

Last modified on 20 August 2010, at 19:21