Meaning of Inflation and its Impact on Consumers

What is Inflation?

Although the definition of inflation is well documented in economics, many people still struggle to understand what inflation really means. A clear definition of the term is not only necessary for students of economics, but also for policy makers who want to understand the level of inflation in their economy for effective economic policies to be formulated.

Inflation refers to the general increase in the prices of goods and services in an economy over time, leading to a decrease in the purchasing power of a currency. In other words, as inflation occurs, each unit of currency buys fewer goods and services than it did before.

Inflation is typically expressed as an annual percentage, representing the rate at which the average price level of a basket of selected goods and services rises. Central banks and economic policymakers often aim for a moderate level of inflation as it can indicate a healthy, growing economy. However, excessive inflation or deflation (a decrease in the general price level) can pose economic challenges.

It may be easy to measure the price changes of a few products and services over time, but human wants are unlimited. Inflation measures the overall price changes of a combination of all products – it measures price changes for a diversified set of products rather than focusing on a single product or few products.

Individuals or households need to understand what is inflation quite clearly so that they can make the right buying decisions. Since inflation or rise in product prices leads to reduced purchasing power, consumers are impacted negatively through increased cost of living. When inflation rises, consumers are not able to buy what they used to buy before.

In economic theory, sustained inflation may occur when a country’s money supply grows faster than economic growth. This concept helps economists and policymakers to regulate money supply through monetary policies to ensure that sustained inflation is not reached.

Monetary authorities, usually the Central Bank, plays a role in managing money supply to ensure that inflation is contained within manageable and acceptable limits.

Theoretically, monetarism is a popular theory that explains the relationship between inflation and the money supply of an economy. For example, following the Spanish conquest of the Aztec and Inca empires, massive amounts of gold and especially silver flowed into the Spanish and other European economies. Since the money supply rapidly increased, the value of money fell, contributing to rapidly rising prices

Leave a Reply

Your email address will not be published. Required fields are marked *