Economic Definition of Inflation

What Is Inflation? Inflation is a rise in prices or the decline of purchasing power over time, reflected in an average price increase of goods and services. This rise means that a unit of currency buys less than before. You can feel the effects of inflation when demand exceeds supply, leading to shortages.

While it is easy to track price changes of specific products over time, human needs go beyond needing only a few products. Consumers require a daily dose of various products and services to live a comfortable lifestyle. These products and services may include commodities like food, fuel, electricity, and transportation, not to mention healthcare, entertainment, and maintenance.

According to the US Bureau of Labor Statistics, you could buy $20 worth of groceries years ago and get enough to feed a family of four. However, at the current rate of inflation, that is not possible in 2023. Right now, those items would cost almost $200. That’s an unbelievable increase. Well, thanks to the different types of inflation, it happens to be true. But what causes inflation?

What Are The Cause of Inflation?

The most common reason for a price hike is buyers want more of the products or services that are not available. There must be a reason that the product is out of stock for it to support the price change. Unless there is a cause, the price does not have to go up. Prices inflate because sellers know buyers will pay more for something they want wholeheartedly.

Prices rise, and when they do, consider buying cheaper products or finding another means to get the services you want to be done. This loss of purchasing power impacts the cost of living for the common public, ultimately leading to a deceleration in economic growth. The opinion and view among economists are that sustained inflation occurs when a nation’s money supply growth outpaces economic growth.

With a given amount of money, consumers purchase fewer goods and services. As prices rise, it affects the cost of living. Economic growth moves slowly, and the public loses purchasing power.

Increased money supply

Ideally, an increase in money lowers interest rates, encouraging spending and investing, and boosting gross domestic product (GDP).

But when the money supply develops faster than the economy (i.e., quantitative easing (QE), this process, started by the Federal Reserve, can also result in demand-pull inflation.

Rising wages

Because wages are a cost, rising wages contribute to cost-push inflation. When workers receive higher earnings, it costs more for them to produce, and the consumers or buyers eat those costs. With that said, the buyers are affected by those costs or pay raises.

Higher salaries put more money in the pockets of the people who spend the money. By doing so, they increase the demand for products and services. People can bargain for higher wages to offset inflation.

Monetary and fiscal policies

The Federal Reserve is responsible for maintaining the monetary policy in the United States.

The central bank reduces inflation through contractionary monetary policy during times of high inflation. When the economy is facing a slump and fails to maintain a balance between policies, the Fed’s expansionary monetary policy can lead to inflation.