Factors of Inflation

Factors of Inflation

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The term "inflation" refers to a general rise in the prices of goods and services over time throughout the economy, reducing consumers' and businesses' purchasing power. To put it another way, the value of your dollar, or whatever currency you use to make purchases, will not be as high as it was yesterday. Take a product that is commonly used and compare its price over time to understand the effects of inflation. For instance, the average price of a cup of tea in 1970 was paisa; It had increased to Rs1.50 by 2019.Therefore, in 2019, you could purchase approximately three cups of coffee for Rs5, compared to 20 cups in 1970.That is inflation, and it goes beyond price increases for just one good or service; It is used to talk about price increases in a country's economy and, ultimately, in a sector like retail or the automotive industry.

Economists consider annual inflation to be a sign of pricing stability in a healthy economy to be between two and three percentage points. In addition, inflation can have positive effects when it is within a reasonable range: For instance, when the economy is slowing down and in need of a boost, it can encourage spending, which in turn increases demand and productivity. On the other hand, when inflation begins to outpace wage growth, it may indicate that the economy is in trouble. Consumers are most directly affected by inflation, but businesses can also feel it. A brief explanation of how consumers and businesses are affected by inflation is as follows:

1. When food, utilities, and gasoline prices rise, households—also known as consumers—lose their purchasing power.

2. When prices rise for production inputs like raw materials like coal and crude oil, intermediate products like flour and steel, and finished machinery, businesses lose purchasing power and run the risk of seeing their margins shrink. To counteract inflation, businesses typically raise the prices of their goods and services, which means that consumers bear the costs. The challenge for many businesses is to strike a balance between raising prices to cover increases in input costs and ensuring that they do not rise so much that they reduce demand, as will be discussed later in this article.

Measurement of inflation

A price index, or "basket" of various goods and services used by households, is first used by statistical organizations to measure inflation. Agencies compare the value of the index over one period to another, such as month to month, which yields a monthly rate of inflation, or year to year, which yields an annual rate of inflation, in order to calculate the rate of inflation, also known as the percentage change over time.

Inflation is primarily caused by two things:

Demand-pull Inflation - When the economy's demand for goods and services exceeds its capacity to produce them, demand-pull inflation occurs. For instance, an interruption in the supply of semiconductors made it difficult for the automotive industry to keep up with this renewed demand when the demand for brand-new automobiles recovered more quickly than anticipated from its sharp decline at the beginning of the COVID-19 pandemic. Prices for both new and used cars went up as a result of the subsequent shortage of new vehicles.

Cost-push Inflation - When the price of input goods and services rises, the price of final goods and services rises. This phenomenon is known as cost-push inflation. During the pandemic, for instance, fundamental shifts in demand, purchasing patterns, cost to serve, and perceived value across sectors and value chains led to a sharp rise in commodity prices. Industrial businesses were forced to consider price increases that would be passed on to their end customers in order to offset inflation and minimize the impact on financial performance.