What is Inflation? Inflation is the rate at which goods and services increase in price in a specific economy. Inflation is measured as a percentage. While inflation is normal and often good for economic growth, there are extreme cases that can disrupt stability and create financial hardship. Simply put, Inflation is the rate at which prices for goods and services rise. Inflation is sometimes classified into three types: demand-pull inflation, cost-push inflation, and built-in inflation.
Inflation is a general rise in the price of goods in an economy. Demand-pull inflation causes upward pressure on prices due to shortages in supply, a condition that economists describe as "too many dollars chasing too few goods." An increase in aggregate demand can also lead to this type of inflation.
In Keynesian economics, an increase in aggregate demand may be caused by a rise in employment, as companies need to hire more people to increase their output. A tight labor market means higher wages, which translates into greater demand.
Cost-push inflation (also known as wage-push inflation) occurs when overall prices increase (inflation) due to increases in the cost of wages and raw materials. Higher costs of production can decrease the aggregate supply (the amount of total production) in the economy. Since the demand for goods hasn't changed, the price increases from production are passed onto consumers creating cost-push inflation.
Built-in inflation occurs when workers expect their salaries or wages to increase when prices of goods and services increase to help maintain their living costs. Built-in inflation can be viewed as a double-edged sword. As laborers demand higher pay, the cost of production increases, which can raise the cost of living.
Measuring inflation is essential for a variety of reasons. Doing so allows the government to form monetary policies that can help boost the economy, set interest rates, wages, and welfare benefits, and help individuals plan for their financial future. There are numerous ways you can measure inflation, such as indices, formulas, and even inflation calculators. Take a look at how each inflation measurement works below.
Inflation is often measured using price indices. These indices measure changes in the average price of market baskets, such as a set of goods and services (e.g., cosmetics, meat, fruits, and vegetables). Below are two popular price indices.
Consumer Price Index (CPI)
The Consumer Price Index (CPI) (The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Indexes are available for the U.S. and various geographic areas), is the most common index and is used by the U.S. Bureau of Labor Statistics. The CPI measures the average change over time in the prices consumers pay for a market basket of services and goods. The eight most common expenditure groups include:
Transportation, medical care, housing, apparel, recreation, education and communication, Food and beverages and other goods and services
Over 200 categories spread across each of the eight major groups, and the BLS records about 80,000 consumer prices each month. The CPI is calculated by dividing the price of a market basket in a particular year by the price of the same market basket in the base year. Inflation is then measured by calculating the change of price between the market basket of each year. The CPI measures the retail price of a product or service that’s available to individual consumers. The CPI is often the most-used indicator of inflation or deflation because it’s associated with the cost of living. The most commonly used inflation indexes are the Consumer Price Index and the Wholesale Price Index.
Inflation can be viewed positively or negatively depending on the individual viewpoint and rate of change.
Those with tangible assets, like property or stocked commodities, may like to see some inflation as that raises the value of their assets.