What is Inflation?

You might have heard your grandparents or great-grandparents reminiscing about how, in their time, they could buy several litres of oil for just 5 rupees or a good amount of grains and pulses for only 1 rupee. Today, those same items are much more expensive, and a single rupee might only buy a small toffee or chocolate. This change over time is a clear example of inflation!

What is Inflation?

Inflation is the term used to describe the rise in the prices of everyday goods and services like food, housing, clothing, transportation, recreation, and consumer essentials. It is measured by tracking the average price change of a group of goods and services over a specific period. It is calculated in India by the Ministry of Statistics and Programme Implementation.

For example, if a kilogram of apples cost Rs. 100 in 2019 and Rs. 110 in 2020, the cost of apples would increase by 10%. Similarly, the prices of many goods and services that have risen over time are grouped together, and the percentage increase from a base year is calculated. This percentage increase in the prices of the group of goods and services is known as the rate of inflation.

Types of Inflation or Causes of Inflation

1. Demand-Pull Inflation:

Demand-pull inflation occurs when an increase in the supply of money and credit leads overall demand for goods and services to rise more rapidly than the economy's production capacity, resulting in price increases.

When people have more money, it leads to positive consumer sentiment. This, in turn, leads to higher spending, which pulls prices higher. It creates a demand-supply gap with higher demand and less flexible supply, which results in higher prices.

For example :

Assume a pen vendor sells one pen for Rs.10 in 2023. But in 2024, the same vendor increases the price of the pen and sells it at Rs. 20 due to high demand, possibly driven by a new trend.

2. Cost Pull inflation:

When people have more money, they tend to feel better about spending. This leads to increased spending, which then causes prices to go up. This happens because there is more demand for goods and services, but the supply isn't able to keep up, which leads to higher prices.

Let's understand with the same example of a pen vendor, Assume a pen vendor sells one pen for Rs.10 in the year 2023. But in the year 2024, the same vendor increased the price of a pen and sold it at Rs. 20 due to high demand; this could be due to an increase in the cost of raw materials like plastic cost, ink price, printing price, etc that is used to make pen.

3. Built-in inflation:

People’s built-in inflation is connected to their adaptive expectations, which means they expect current inflation rates to continue in the future. When the cost of goods and services goes up, people may expect a similar continuous rise in the future.

As such, workers might ask for higher wages to maintain their standard of living. When they receive higher wages, the cost of goods and services goes up. This creates a cycle where higher wages lead to higher prices and vice versa.

In this chapter, we explored the concept of inflation and how it impacts the cost of goods and services over time. We discussed the different types of inflation, including demand-pull, cost-push, and built-in inflation, and how they contribute to rising prices in the economy. Through examples, we illustrated how inflation affects purchasing power and creates economic challenges for consumers and businesses alike.

As we move into the next chapter, we will examine the broader impact of inflation on everyday expenses, businesses, and the overall economy. We'll delve into how inflation influences financial planning, investment decisions, and consumer behaviour, providing insights on how to navigate these changes effectively.