Economists say that inflation refers to as a continual rise in the general level of prices. An increase in the general level of prices for goods and services will cause a decrease in the purchasing power of the currency. While inflation is defined as an increase in the level of prices, not all of these prices necessarily change by the same proportion or even in the same direction. FIND AN EXAMPLE Because of this, inflation affects the distribution of real income and wealth among individuals and households.
Inflation can cause many significant economic effects. For example, it can have an impact on the distribution of national income and wealth. The relative rates of inflation in Australia and inflation rates overseas can influence international competitiveness. A low and stable rate of inflation is desired for the welfare of the economy and for individual benefit.
The most common way to measure inflation is to calculate the rate of change of the Consumer Price Index (CPI). The CPI summarises the overall change in the prices of a large number of goods and services. The CPI is based on a sample of a range of goods and services arranged in the following eleven groups:
This sample of goods is referred to as the regimen (the different groups of goods and services included in the sample). In Australia, the CPI is calculated by the Australian Bureau of Statistics (ABS) and is compiled on a quarterly basis by collecting approximately 100,000 price quotations. The ABS attaches a weight to each item in the CPI regimen in order to reflect its importance to the ‘average’ household. For example the average household would consider a 10% rise in the price of fuel more important than a 10% rise in the price of cellophane. Reviews of the importance of the eleven groups are reviewed every five years in order to keep an accurate reflection on the household’s buying patterns and what is considered important. For example, ‘average’ households in the last decade have been found to buy more leisure and recreation goods than before; thus, the price movements have become more important.
It must be taken into consideration that the CPI does not account price movements that are outside of metropolitan areas and also does not represent the true cost of living as it does not show the changes of consumer or substitutions of preferences on a day to day account compared to relative price changes.
The rate of inflation refers to the rate at which prices are changing and is conducted from the CPI. The rate of inflation is calculated from the CPI using the following formula:
Quarterly rates of inflation can still be found using the same formula but instead using quarterly results instead of yearly.
Causes of Inflation
There are various causes for inflation, depending on a number of factors. Inflation can often occur when too much money is printed in order to deal with a crisis. As a result, prices end up increasing at an extremely high rate to keep up with the currency surplus. This is known as demand-pull inflation, where we have ‘too much money chasing too few goods.’ And the economy is said to be ‘overheated’. Therefore, prices are forced upwards because of a high demand and/or the purchasing power of the money decreases.
Demand-pull inflation arises when aggregate demand in an economy exceeds aggregate supply. It involves inflation rising as real gross domestic product rises and unemployment falls. This would not be expected to persist over time due to increases in supply, unless the economy is already at a full employment level. Fortunately for consumers, the effects of demand-pull inflation are generally short-term.
Demand pull-inflation occurs when demand for a product increases and firms cannot keep up with the new level of demand so, rather than increase the supply of the product they raise the prices in order to eliminate the excess demand....