25 Jul Inflation Concept
Inflation is an economic concept that refers to the rate at which the general level of prices for goods and services is rising, and subsequently, the purchasing power of a currency is falling. Inflation is typically expressed as an annual percentage, indicating the percentage increase in the overall price level over a specific period, usually a year.
Inflation can have various causes, but the most common ones include:
- Demand-Pull Inflation: This occurs when the demand for goods and services exceeds their supply, leading to upward pressure on prices.
- Cost-Push Inflation: This type of inflation is driven by an increase in production costs, such as higher wages or raw material costs, which results in higher prices for consumers.
- Built-in Inflation: Also known as wage-price inflation, it happens when businesses raise prices to compensate for increased labor costs, and workers demand higher wages to keep up with rising prices, creating a self-reinforcing cycle.
Central banks and governments often target a certain level of inflation, typically around 2%, as a way to promote economic stability and growth. Moderate inflation can encourage spending and investment, but high or unpredictable inflation can erode purchasing power, create uncertainty, and negatively impact economic growth.
Two common measures of inflation are the Wholesale Price Index (WPI) and the Consumer Price Index (CPI):
- Wholesale Price Index (WPI): WPI measures the average change in the prices of goods at the wholesale level within an economy. It tracks the price movements of a basket of goods that are sold in bulk before they reach the retail level. WPI includes commodities like raw materials, fuel, food items, etc. Changes in WPI can influence prices at the retail level, affecting consumers and businesses. However, since it focuses on wholesale prices, it might not fully capture the price changes experienced by the end consumers.
- Consumer Price Index (CPI): CPI, on the other hand, measures the average change in prices that urban consumers pay for a specific basket of goods and services. It reflects the cost of living and is more directly relevant to individuals as it represents the inflation experienced by consumers. The CPI basket includes items like food, housing, transportation, healthcare, education, and other goods and services purchased by consumers. It is a crucial indicator for assessing changes in the cost of living and is commonly used to adjust salaries, pensions, and social benefits to maintain purchasing power.
Both WPI and CPI are essential tools for policymakers, businesses, and individuals to understand and manage inflationary trends, make economic decisions, and formulate appropriate monetary and fiscal policies.