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Inflation refers to a rise in the general price level of all commodities over a time period. It is indicated by the rise in prices that is persistent and substantial. Inflation in economics does not mean abrupt price fluctuations of a few commodities but an overall increase in aggregate price level across the economy.
Inflation in economics is analysed by the community’s aggregate income and expenditure patterns regarding the availability of goods and services. When the demand for goods and services increases but the supply of the same does not increase proportionally, there will be a rise in the general price level leading to inflation.
Types of Inflation
There can be different types of inflation in economics, depending on its magnitude and impact on the economy. These can be categorised as follows:
Creeping Inflation: This type of inflation occurs when there is a price rise at a very slow pace. Such inflation is controllable and considered beneficial for economic growth.
Walking Inflation: Walking inflation is where the rate of price rises by 3% to 10%. This type of inflation can be considered a warning signal for the government to take necessary measures.
Running Inflation: This causes a rapid and substantial rise in prices by 10 to 20%. Such inflation is likely to affect the economy and requires strong monetary measures.
Causes of Inflation
To better understand inflation in economics, we need to get an idea about the possible causes of inflation. Some of these are mentioned as follows:
Increase in Income: The increase in money supply with higher purchasing power in people increases the consumption and demand for goods, thus resulting in inflation.
Factors Affecting Output: The output of goods and services may not increase due to a shortage of the factors of production, such as land, workforce, capital, raw material, and technical support. In such cases, the price of products rises, leading to inflation.
Role of Expectations: Inflation may happen because of expectations regarding future changes in price and wages. Expectations of wage rise may induce price rise in advance, and an expectation of price rise leads to the demand for more goods. These speculations further increase the price and lead to inflation.
Effects of Inflation on Economy
Economic growth and inflation are interconnected because lower inflation has a positive impact on the economy. Still, when raised above a certain level, inflation can cause major disturbances in economic stability. The increased prices of goods and services impact the cost of living, the cost of doing business, and every aspect of the economy. The various disturbing effects of inflation can be described as follows:
Reduction of Purchasing Power
The direct impact of inflation can be seen in the reduction of the purchasing power of people. A certain amount of goods can be purchased with a certain amount of money. When inflation occurs, one can purchase a lesser amount of the same goods with the same amount of money. This explains how the purchasing power of money is reduced due to inflation.
In other words, inflation leads to a reduction in the value of money. The most adversely affected section is the salaried class and daily wage earners who find it very difficult to maintain livelihood as income does not rise, but the cost of living increases due to inflation.
Devaluation of Money
The foreign exchange rate also reduces as an effect of inflation due to a fall in the value of money. The fall in the purchasing power of money will depreciate the currency value compared to the foreign exchange. So, one unit of foreign currency will be costlier in terms of the currency of a particular country experiencing inflation. This depreciation will affect the trade by making the exports costlier. The consequence of this inflation will also be observed in the price rise of the necessities that the country has to import.
Stagflation
This refers to the condition when economic growth and inflation counteract, causing stagnation of the economy. The stagnation occurs due to various reasons which are related to inflation. There may be a shortage and irregular supplies of raw material, components, power, and infrastructural support. Usually, a mixed economy is more prone to experience stagnation of growth and employment at the same time when price increases occur due to inflation.
Conclusion
Inflation is defined as the increase in the price of products and price over a given period. Inflation in economics signifies a struggling economy where some people tend to spend and invest more, and others suffer due to low purchasing power. Rising prices lead to higher costs and a further rise in price that boosts inflation. As people and businesses spend more quickly to utilise their depreciating currency without adequate supply, the economy becomes chaotic. Hence, in the long run, inflation can have an adverse effect on the economy.
