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Inflation? What Does it Mean and What Can You Do?

What Causes Inflation and Who Profits From It?

Inflation. It’s a word that gets tossed around a lot, but what does it actually mean? And more importantly, what can you do to protect your money from inflation? In this blog post, we’ll break down inflation for you and give you some tips on how to stay ahead of it. So sit back, relax, and let us teach you about one of the most important concepts in finance!

What is inflation?

Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. It is measured as an annual percentage change. The most well-known measure of inflation is the consumer price index (CPI).

Inflation can have various effects on an economy. For example, it can reduce the purchasing power of consumers and lead to higher interest rates. It can also distort relative prices and encourage people to spend more money on some goods and services than others.

There are two main types of inflation:

  • Demand-pull inflation and
  • Cost-push inflation.

Demand-pull inflation occurs when there is an increase in demand for goods and services that exceeds the economy’s ability to supply them. Demand pull inflation is a function of rising incomes. When people have more disposable income, they show greater demand for goods.

Beyond a certain level, the production capacity of a country starts to heat up as businesses struggle to supply goods and services and this causes demand pull price increase.

A common tool to deal with demand pull inflation is to increase interest rates. In this way loans become expensive and people are discouraged from borrowing. This also makes bank deposits more lucrative as people can earn higher interest rate by parking their savings in banks instead of investing in business.

Cost-push inflation occurs when there is an increase in the cost of production, such as an increase in the price of oil or other commodities. Right now the world is experiencing cost push inflation. Since the pandemic struck, the global supply lines have been disrupted. Regional conflicts have added to this inflationary pressure.

Cost push inflation results in increase in price levels, while the disposable income remains the same. This means that the net effect makes people worse off in cost push inflation as compared to demand pull inflation.

Cost push inflation is more difficult to control because monetary and fiscal policy tools cannot directly control the factors that are causing inflation in the first place.

How is inflation calculated?

In order to calculate inflation, economists use a variety of methods, the most common being the consumer price index (CPI). The CPI is a measure of the average change in prices paid by consumers for a basket of goods and services.

The CPI basket includes a wide range of items, from food and housing to transportation and healthcare. The weights of each item in the CPI basket are based on how much consumers spend on each item.

For example, the weight of food in the CPI basket is much higher than the weight of transportation because people spend more money on food than they do on transportation.

The CPI is calculated by comparing the prices of a selection of goods and services from one period to another. The most common time periods used are monthly, quarterly, and annual.

To calculate inflation for a specific good or service, economists use the prices of a representative sample of goods and services from a given period. They then compare these prices to the prices of the same goods and services in a different period.

The difference in prices is then multiplied by the weights of the goods and services in the CPI basket to get the inflation rate.

Causes of inflation

There are many different factors that can contribute to inflation. One of the most common, as discussed above, is an increase in the cost of raw materials and production inputs. This can happen due to a variety of reasons, including sudden spikes in commodity prices, weather-related shortages, or political instability in key producing regions.

Another major cause of inflation is excessive money printing by central banks. This can lead to too much money chasing too few goods, driving up prices and eroding the purchasing power of consumers.

Additionally, government spending can also be a major factor, as it can lead to increases in government debt and higher interest rates. All of these factors can work together to create an environment of rising prices and decreased purchasing power.

The effects of inflation

Inflation can have a number of different effects on an economy. One of the most obvious is that it decreases the purchasing power of consumers, as their money is worth less and less over time. This can lead to a decrease in consumption and economic growth. Additionally, inflation can also lead to higher interest rates, as lenders will demand higher returns to compensate for the loss in value of money.

Inflation can also create an environment of uncertainty, as businesses and consumers alike are never quite sure how much prices will increase in the future. This can lead to reduced investment and economic activity, as businesses are hesitant to make long-term plans. 

Finally, inflation can also be a redistributive force, as those with fixed incomes or savings will see their purchasing power decline while those with debt will benefit from lower real interest rates.

How to protect yourself from the effects of inflation

The effects of inflation can be insidious, gradually eating away at your purchasing power and eroding your standard of living. But there are steps you can take to protect yourself.

One way is to invest in assets that tend to increase in value as inflation rises. These include real estate, commodities like gold, and collectibles. You can also invest in stocks, bonds, and other financial instruments that offer protection against inflation.

Another way to guard against the effects of inflation is to increase your income. This can be done by working harder or smarter, or by investing in yourself through education and training.

Conclusion

Inflation can have a number of different effects on an economy, some of which are illustrated in the article. One way to protect oneself from the negative effects of inflation is to invest in assets that will retain their value or even increase in value over time. Additionally, one can try to increase their income so that they can maintain their purchasing power despite rising prices. By taking these steps, you can help to ensure that you maintain your purchasing power and safeguard your standard of living.

Eyes On: What’s the Australian Government Doing to Help The Economy Recover For 2021

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Dave P
Dave P
Be a little better today than yesterday.
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