WHAT IS INFLATION

Inflation is a measure of the rate at which the price of goods and services have increased over a period of time. It is usually expressed as a percentage, inflation indicates a decrease in the purchasing power of a nation’s currency. When prices rise, they start to affect the general cost of living for the common public and when this happens, the appropriate monetary authority of the country, like the central bank, then takes the necessary measures to keep inflation within acceptable limits and keep the economy running smoothly. Inflation is measured in a number of ways depending upon the types of goods and services considered. The opposite of deflation which indicates a general decrease occurring in prices for goods and services when the inflation rate falls below 0 percent.

Imagine your grandma stuffed a N100 note in her old handbag in the year 1975 and then forgot about it. Cost of a bottle of malt during that year was around N20 per bottle, which means she could have then bought 5 bottles of malt with that N100 note. Twenty-five years later in the year 2000, the cost of that same bottle of malt was around N80 per bottle. If she finds the forgotten note in the year 2000 and then went on to buy the same bottle of malt, she would have got only 1 bottle. Although the N100 note remained the same for its value, it lost its purchasing power. This simple example explains how money loses its value over time when prices rise. This phenomenon is called inflation.

CAUSES OF INFLATION

Price rise is the root of inflation, though it can be attributed to different factors. In the context of causes, inflation is grouped into three types: Demand-Pull inflation, Cost-Push inflation and Built-in inflation.

Demand-pull inflation occurs when the overall demand for goods and services in an economy increases more than the economy’s production capacity. It creates a demand-supply gap which higher demand and lower supply, which results in higher prices. For instance, when the oil producing nations decide to cut down on oil production, the supply diminishes. It leads to higher demand, which results in price rises and contributes to inflation. Additionally, increase in money supply in an economy also leads to inflation. With more money available to the individuals, the positive consumer sentiment leads to higher spending. This increases the demand, and leads to price rise. Money supply can be increased by the monetary authorities either by printing and giving away more money to the individuals, or by devaluing (reducing the value of) the currency. In all such cases of demand increase, the money loses its purchasing power.

Cost-push inflation is as a result of increase in the prices of production process inputs. Examples include increase in labor costs to manufacture a good or offer a service, or increase in the cost of raw material. These developments lead to higher cost for the finished product or service, and contribute to inflation.

Built-in inflation is the third cause that links to adaptive expectations. As the price of goods and services rises, labor expects and demands more costs/wages to maintain their cost of living. Their increased wages result in higher cost of goods and services, and the spiral continues as one factor induces the other and vice-versa

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