Inflation Definition – What is Inflation? | CFI LB

inflation

Inflation is generally quoted in percentages and is the measure of the average price at which a select basket of goods and services in a country rises over a specific period.

 

Inflation demonstrates the rise in prices in a country and therefore the reduced purchasing power of the country’s currency over that period. The opposite of inflation is known as deflation, which is where prices are decreasing over the specified period.

 

The three major types of inflation are:

 

Built-in inflation

 

Built-in inflation is when future expectations become factored into pricing, for example, a workforce will demand higher wages to compensate for an increased cost of living, and therefore, the cost of goods or services provided by the workers’ employers increase so that the employer’s profit margins are protected.

 

Demand-pull inflation

 

Demand-pull inflation occurs when the market demand for goods and services is greater than the ability to produce them, resulting in a demand-supply gap that is capitalized on by either the original supplier to the market or third-parties seeking to profit by re-introducing the volume they have procured back into the market at inflated prices.

 

Cost-push inflation

 

Cost-push inflation is often exhibited when the cost of production increases. Good forecasting and financial planning would expect, and allow for, certain occurrences, and therefore many factors in cost-push inflation become built-in inflation.

 

However, in the food industry, for example, an unexpected drought in a country key to the production of the world’s wheat supply, resulting in an unexpected shortage in supply to the market would likely lead to demand-pull inflation in the price of wheat. This price rise increases the cost of production of any product containing wheat and would likely result in a rise in the price of the final product to consumers.

 

Controlling inflation

 

Central banks monitor their country’s inflation rate closely and try to control the inflation rate by utilizing various monetary policies. These policies will aim to control the money supply within the country’s economy and therefore control the rate of inflation in an attempt to hit the central bank’s long-term inflation rate target.

 

Central banks will aim to have a stable inflation rate as it will allow businesses in the economy to better prepare for the future as they will know what to expect in regards to many economic factors such as labour and production costs and likely future selling prices received for their products or services.

 

Key takeaways:

 

  • Inflation, in general terms, is the rate at which a basket of goods and services increases over time
  • There are three major types of inflation: built-in inflation, demand-supply inflation, and cost-push inflation
  • Central banks aim to keep their country’s inflation rate stable and on target as this helps businesses to plan, contributing to a stronger economy
  • Central banks use monetary policy in an attempt to control the inflation rate
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