To put it in simplest terms: inflation is a rise in the prices of goods and services over time. In other words, it represents a drop in purchasing power in a given period.
Purchasing power is how much of a given good or service you can get for a fixed price. As inflation rises, it shows that purchasing power diminishes.
Think about it like a basket of groceries. As purchasing power drops, you can get fewer goods for a given price. As a result, you need to pay more money to get the same amount of goods in the original grocery basket.
Economic Impact Relative to Inflation
The idea of inflation rates is to measure an overall impact that many consumer goods and services have on purchasing power. These goods and services are generally regarded as a measurement of living a decent, comfortable life.
This means having all the following:
- Food you need
- Appropriate housing
- Transportation (vehicles, gas)
- Entertainment, recreation, fitness
As prices rise, the same amount of money gets you less. And this has a residual effect on the overall cost of living for the public.
Decelerating Economic Growth
If inflation rises at a rapid rate, consumers can no longer buy as many of the goods and services they once did with the same amount of money. In situations like the current economy, this leads to a deceleration or slowing of economic growth.
A slowing of economic growth means an overall decrease in engagement with all areas of an economy. Less service business, less purchasing, fewer entertainment expenses, and less disposable income all factor into a cumulative economic effect.
In simpler terms: we all feel strained by getting less for our money. All areas of the economy also feel strained as consumers have less spending power than they did before. In short, it hurts all around.
How Does Inflation Happen?
Three primary factors are what contribute to inflation within an economy.
As demand increases for a product or service, it can sometimes hit its limit in production or availability. As a result, the price rises.
For example, a wildly popular video game console is released with a predetermined MSRP, but the demand is greater than can be produced. Accordingly, the price for the console goes up.
As production prices increase, consumers inevitably see these increases in their final prices. For example, the price of materials for building a house has increased substantially. To ensure a profit, a contracting and construction company must increase the costs of the home production.
As prices increase, wages paid to employees also increase. A rise in wages is the only way people can endure things like rises in cost of living.
This post offers a fairly simplified spotlight on the basics of inflation. The truth is that all the factors leading to inflation are interrelated and complex.
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