Inflation is the part of the economy that affects wages and prices of goods. Since this can have an impact on your paycheck, it can be helpful to learn more about what causes inflation. Understanding how to calculate inflation can help you visualize how your purchasing power has changed over time.
In this article, we will explain what inflation is, its causes, role and ways to calculate inflation easily.
Table Of Contents
1 What is inflation?
2 Types of Inflation Index
2.1 Consumer price index
2.2 Price index of personal consumption expenditure
2.3 Wholesale price index and producer price index
3 Causes of inflation
3.1 1. Inflation pulls demand
3.2 2. Cost-push inflation
3.3 3. Built-in inflation
4 How to Calculate Inflation?
4.1 The following is the basic formula for inflation:
5 Advantages of inflation
5.1 Disadvantages of inflation
What is inflation?
Inflation is a measure of the increase in the average price of goods and services over time. When inflation goes up, it means you have to spend more money on the same goods.
Inflation reduces people’s purchasing power. When prices go up, people can buy less. Some businesses provide employees with an increase in the cost of living each year to ensure their salaries are in line with inflation rates.
This increase helps employees buy the same products and goods that may be more expensive due to inflation.
Inflation is usually expressed as a percentage to indicate the rate of increase. The inflation rate shows how prices rise in a year or month.
The acceptable inflation rate is usually around 2%.
Types of Inflation Index
The inflation index is a database that economists use to measure inflation based on various factors. Inflation indexes can help analysts identify the causes of inflation and make economic predictions. Here are some types of inflation indices:
Consumer price index
The consumer price index (CPI) tells you about the general level of inflation. The CPI is a tool used and the Ministry of Finance to measure inflation. They gather information by surveying households about what they buy.
The CPI only includes expenditures for goods and services that are paid directly by households.
Personal consumption expenditure price index
The personal consumption expenditures (PCE) price index measures inflation and is based on a survey of what businesses sell.
It is published by the Bureau of Economic Analysis. It combines more goods and services than the CPI. For example, it includes medical care paid for by insurance such as Medicaid or by business owner’s insurance, which is not included in the CPI.
Wholesale price index and producer price index
The wholesale price index and the wholesale price index (WPI) measure the gradual fluctuations in the price of goods before the retail level. For example, it includes the price of raw materials. PPI or u producer price index. The PPI measures price changes from a seller’s point of view.
Causes of inflation
There are three types of inflation:
1. Inflation pulls demand
Demand-pull inflation is an increase in prices caused by a lack of supply. If the demand for goods increases faster than the production capacity of these goods, there will be a gap.
When demand is higher than supply, prices go up, and that contributes to inflation. Demand-pull inflation also occurs when the money supply increases. When they have more money available, consumers spend more and demand increases, which causes prices to rise.
2. Cost-push inflation
When it costs more to produce goods because of rising wages or higher raw material prices, the result is cost-push inflation. Other factors in cost-push inflation include demand for products that remain the same.
If there is no increase in demand for a good, then producers do not need to produce more. The company then sets a higher price so that consumers compensate for the increase in production costs.
3. Built-in inflation
Due to rising prices, the labor force adjusts and demands higher wages to support their cost of living. This higher salary leads to an increase in the cost of goods and services. This creates a spiral where one factor affects another and vice versa.
How to Calculate Inflation?
Knowing how to calculate inflation can tell you about the evolution of a product’s price over time and understand how the purchasing power of a currency has changed over that period.
Here’s the basic formula for inflation:
Inflation = Final CPI Index / Initial CPI Value
You can find tables with inflation index data on many portals. From one of these tables, select the CPI of the period you are viewing.
Example: You want to know inflation between July 1981 and July 1989.
In July 1981, the initial CPI value was 90.6 and for July 1989, the final CPI value was 108.1. Using the formula:
Inflation = (108.1/ 90.6) = 1.20
This means that the value of 1,000 rupees in 1981 had a value of 1,200 rupees in 1989.
If you wanted to calculate the rate, you would use the formula:
([Final CPI Index Value-Initial CPI Value] / Initial CPI Value) x 100
Inflation rate = ([108.1-90.6] / 90.6) x 100 = 19.31%
Prices increased 19.31% over 8 years (between 1981 and 1989).
There are also many inflation calculators available online that find information for the date you entered.
Inflation gain
There are three main advantages of inflation:
- When the government can manage it, inflation can encourage economic growth. When prices fall (negative inflation or deflation), consumers tend to delay their purchases because they expect a sustained decline in prices.
- An increase in inflation can indirectly increase productivity. When prices rise, firms increase their production to earn more money. The labor force is working more to maintain its purchasing power.
- When inflation is too low, the economy can go into a recession. Therefore, if countries have a choice, they prefer inflation to deflation.
Disadvantages of inflation
When the inflation rate is higher than usual, it can lead to economic challenges such as:
- Inflation can cause a decrease in real wages. If prices rise faster than income, the use of his salary decreases. This most affects fixed income groups such as salaried people and retirees because, during inflation, their purchasing power diminishes.
- Inflation can hinder investment and long-term economic growth. When inflation occurs, the central bank tries to reduce the money supply by raising interest rates. It is more expensive for people and businesses to borrow, and their existing loans become a heavier burden.
- Inflation can make a country less competitive. For example, if the price is too high, they cannot export as well as others.
- Inflation can reduce the value of savings. If inflation is higher than interest rates, this can affect your savings.