What is Inflation? Inflation is generally described as a rise in the average price level of goods and services or a decrease in the purchasing power of the standard unit of currency. While that definition may be a bit difficult for some to comprehend, the effects of inflation are not.
In simple terms, inflation means your dollar does not buy as much as it did before. As a result, a set amount of goods or services will cost you more when inflation rises than it did previously.
For example, the United States Department of Labor, Bureau of Statistics, indicates that from 2003 to 2013, the cumulative inflation rate in the United States was approximately 26%. This means what cost $1 in 2003 would cost around $1.26 ten years later.
The United States government calculates the inflation rate based on the consumer price index (CPI), also sometimes called the cost-of-living index. To identify the CPI, a sampling of prices from hundreds of frequently purchased consumer goods and services are taken monthly at multiple locations around the country. The average cost of those items are then compared with those from previous samplings to determine the Consumer Price Index.
By using many different items, temporary or industry specific price fluctuations are balanced by the remaining items. For example, using the same period from 2003 to 2013, the average cost of a pound of bananas during January of those years went from $0.53 per pound to $0.61 per pound. This equates to a cumulative increase of just 15% which is much lower than the aforementioned inflation rate of 26%.
However, that same ten year period saw a loaf of white bread increasing from $1.04 per loaf to $1.42. Calculating that difference results in an increase of approximately 36%, or ten percent more the average inflation of the same period. Thus, the importance of sampling many different items is apparent.
But what causes inflation? Economists generally agree that there are three major factors that may create inflation.
The first, and most common, is known as demand-pull inflation. Broken down to its simplistic elements, demand-pull inflation happens when consumer demand for products is greater than the supply. Sellers must raise the price of their products, or a sell-out will occur.
Cost-push inflation is created on the seller end. Sellers raise their prices in an attempt to pass on increased production costs to the consumer.
Finally, money supply expansion can also be a factor in inflation. As more money is allowed into the economy (either through fiscal or monetary policy), inflation can occur as consumers have access to that additional money and will likely use it to purchase more items.
No matter the cause, inflation can be both a positive and negative effect on the economy overall. Most, however, consider a slow and steady rate of inflation as the most beneficial.