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What is Inflation?


The term 'Inflation' is included in the Economics edition of the Financial Dictionary. Get yours now on mazon in ebook or paperback format. Read more here...

Inflation proves to be prices rising over time. It is specifically measured as the increase in a given basket of goods and services’ prices. These goods and services are taken to represent the entire economy. Inflation is also the going up in cost of the average prices of goods and services as measured by the CPI, or consumer price index. The opposite of inflation is known as deflation. Deflation turns out to be the falling of an average level of prices. The point that separates the two from each other, both deflation and inflation, is price stability, or no change in the costs of goods and services.

Inflation has almost everything to do with the amount of money available. It is inextricably tied to the money supply. This gives rise to the popularly remarked observation that inflation is actually an excessive number of dollars chasing too small a quantity of goods. Comprehending the way that this works is easier when considering an example.

Pretend for a moment that the world possessed only two commodities: oranges that are gathered up from orange trees and paper money created by government. In seasons where rain is limited and the oranges are few as a result, the cost of oranges should go up. This is because the same number of printed dollars would be competing for a smaller number of oranges.

On the other hand, if a bumper crop of oranges are seen, then the cost of oranges should drop, since the sellers of oranges have no choice but to cut prices to sell off their large inventory of oranges. These two examples illustrate inflation in the former and deflation in the latter. The main difference between the real world and this example is that inflation measures changes in the price movement on average of many or all goods and services, and not simply one.

The quantity of money in an economy similarly impacts the amount of inflation present at any given time. Should the government in the example above choose to print enormous amounts of money, then there will be many dollars for a relatively constant number of oranges, as in the lack of rain scenario. So inflation is created by the number of dollars going up against the quantities of oranges that exist, or overall goods and services existing. Deflation, as the opposite of inflation, would be the numbers of dollars dropping compared to the quantity of oranges available.

Because of this, levels of inflation result from four different factors that often work together in combination. The demand for money could drop. The supply of money could expand. The available supply of various other goods might decline. Finally, the demand for other goods increases.

Even though these four factors do work in correlation, economists say that inflation is mostly a currency driven event. This means that in the vast majority of cases, it results from governments tampering with the money supply. Generally, they do this by over printing their own currency to have money to pay for spending, resulting in higher inflation.

The term 'Inflation' is included in the Economics edition of the Financial Dictionary. You can get your copy on mazon in Kindle or Paperback version. See more details here.