What Are Some Of The Main Causes Of Climate Change – Inflation is a measure of how fast the prices of goods and services are rising. If inflation is occurring, leading to higher prices for basic necessities such as food, it can have a negative impact on the overall economy.
Inflation can occur in almost any product or service, including needs-based expenses such as housing, food, medical care, and utilities, as well as necessities, such as cosmetics, automobiles, and jewelry. Once inflation becomes widespread throughout an economy, the expectation of further inflation becomes a major concern in the minds of consumers and businesses.
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Central banks of developed economies, including the Federal Reserve in the US, monitor inflation. The Fed has an inflation target of roughly 2% and adjusts monetary policy to fight inflation if prices rise too much or too quickly.
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Inflation can be a concern because it makes money saved today less valuable tomorrow. Inflation erodes a consumer’s purchasing power and can even interfere with the ability to retire. For example, if an investor earned 5% on investments in stocks and bonds, but the inflation rate was 3%, the investor earned only 2% in real terms. In this article, we will examine the underlying factors behind inflation, the different types of inflation and who benefits from it.
There are various factors that can drive prices or inflation in an economy. Typically, inflation results from an increase in production costs or an increase in demand for products and services.
Cost-push inflation occurs when prices rise due to increases in production costs, such as raw materials and wages. The demand for goods is unchanged while the supply of goods falls due to higher production costs. As a result, increased production costs are passed on to consumers in the form of higher prices for finished goods.
One of the signs of possible cost-push inflation can be seen in rising prices of commodities such as oil and metals, as they are the main inputs of production. For example, if the price of copper rises, companies that use copper to make their products may raise the prices of their goods. If product demand is independent of copper demand, the business will pass on the higher raw material costs to consumers. The result is higher prices for consumers without any change in demand for the products consumed.
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Wages also affect the cost of production and are usually the single largest expense for businesses. When the economy is doing well and the unemployment rate is low, labor or worker shortages may occur. Companies, in turn, raise wages to attract qualified candidates, causing production costs for the company to rise. If the company raises prices due to increased employee wages, cost-plus inflation occurs.
Natural disasters can also increase prices. For example, if a hurricane destroys a crop such as corn, prices can increase throughout the economy since corn is used in many products.
Demand pull inflation can be caused by strong consumer demand for a product or service. When there is an increase in demand for a wide range of goods in an economy, their prices tend to rise. While this is not often a concern for short-term supply and demand imbalances, sustained demand can reverberate through the economy and raise costs for other goods; the result is demand pull inflation.
Consumer confidence tends to be high when unemployment is low and wages are rising—leading to more spending. Economic expansion has a direct impact on the level of consumer spending in an economy, which can lead to high demand for products and services.
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As the demand for a particular good or service increases, the available supply decreases. When fewer items are available, consumers are willing to pay more to get the item – as described in the economic principle of supply and demand. The result is higher prices due to demand-driven inflation.
Companies also play a role in inflation, especially if they produce popular products. A company may raise prices simply because consumers are willing to pay the increased amount. Corporations also freely raise prices when the item for sale is something consumers need for daily existence, such as oil and gas. However, it is consumer demand that provides corporations with the leverage to raise prices.
Built-in inflation occurs when enough people expect inflation to continue in the future. As the price of goods and services increases, people can believe in a continued increase in the future at a similar rate. Because of these shared expectations, workers may begin to demand higher wages in order to anticipate rising prices and maintain their standard of living. Rising wages would result in higher costs for businesses, which could pass these costs on to consumers. Higher wages also increase consumers’ disposable incomes, increasing demand for goods that can push prices even higher. A wage-price spiral can then be established as one factor feeds into the other and vice versa.
The housing market, for example, has seen its ups and downs over the years. If houses are in demand because the economy is experiencing an expansion, house prices will rise. Demand also affects the ancillary products and services that support the housing industry. Building products such as lumber and steel, as well as nails and rivets used in homes, could all see increased demand as a result of higher demand for homes.
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Expansionary fiscal policy by governments can increase the amount of discretionary income for both businesses and consumers. If a government cuts taxes, businesses can spend them on capital improvements, employee compensation or new hires. Consumers can buy even more goods. The government can also stimulate the economy by increasing spending on infrastructure projects. The result can be an increase in demand for goods and services, leading to higher prices.
Just as expansionary fiscal policy can drive inflation, so can loose monetary policy. Expansionary monetary policy by central banks can lower interest rates. Central banks such as the Federal Reserve can lower the cost of lending to banks, which allows banks to lend more money to businesses and consumers. Increased money available throughout the economy leads to more spending and demand for goods and services.
Monetarists understand that inflation is caused by too many dollars chasing too few goods. In other words, the money supply has increased greatly. According to this theory, the value of money is subject to the law of supply and demand, just like any other commodity in the market. As supply increases, value decreases. If the value of money falls, its purchasing power falls and things become relatively more expensive.
This quantity theory of money (QTM) can be summarized in the equation of exchange, which states that the money supply, multiplied by the rate at which money is spent annually (the velocity of money), equals nominal spending in the economy:
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. Thus P (prices) can increase as the money supply increases and/or the velocity of money increases (given a constant amount of goods in the economy).
Money can also lose value due to a general lack of trust or confidence in the issuer of the money. In this case, hyperinflation may even set it as money is seen as completely worthless.
There are several metrics used to measure the rate of inflation. One of the most popular is the Consumer Price Index (CPI), which measures prices for a basket of goods and services in the economy, including food, cars, education and entertainment. So the changes in the prices of this basket are approximated by the price changes in the whole economy. The CPI is often the economic indicator of choice used to measure inflation.
While the CPI measures price changes for retail goods and other items paid for by consumers, it does not include things like savings and investment, and will often exclude spending by foreign visitors.
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In April 2022, the Consumer Price Index increased by 0.3% on a seasonally adjusted basis. But compared to a year ago, the full index rose 10.8%, making it the biggest year-over-year increase since November 1980.
Another measure of inflation is the Producer Price Index (PPI), which reports price changes affecting domestic producers. The PPI measures prices for fuels, agricultural products (meat and grains), chemical products and metals. If the price increases that cause the PPI to rise are passed on to consumers, it will be reflected in the Consumer Price Index.
CPI measures inflation from the perspective of producers; the average selling price they receive for their output over a period of time. Meanwhile, the CPI measures prices from the consumer’s perspective.
The US Bureau of Economic Analysis (BEA) uses the gross domestic product (GDP) deflator (also known as the GDP price deflator) as an additional indicator of the US inflation rate. The GDP deflator measures the aggregate prices of all goods and services produced by the entire nation; it includes both CPI and CPI statistics.
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The personal consumption expenditures index (PCE) is another measure of inflation that tracks price changes in the amount spent on consumer goods and services exchanged in the US economy. The PCE Price Index consists of a broad range of expenditures that is much larger than the basket of goods used in the CPI,
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