This guide will give you an overview of what inflation is, the types of inflation and how it is measured.
What is inflation?
Inflation is the rate at which the prices of goods and services are rising, so when inflation occurs, everything you buy costs more than it did before. The overall level of inflation in the economy can be measured using the Consumer Price Index (CPI). There are three main types of inflation; demand-pull, cost-pull and built-in and understanding each one will help you better predict what might happen to your personal finances in the future.
Demand Pull Inflation
Demand-pull inflation is when there is an increase in aggregate demand (consumers buying more goods) in the market which causes prices to rise
Cost Pull Inflation
Cost-push inflation is when there are increases in the costs of production (workers demanding higher wages) which cause prices to rise.
Built in inflation
Built-in inflation happens as a result of market imperfections such as monopolies or oligopolies that don’t allow for perfect competition and cause prices to be out of sync with supply and demand levels.
How is inflation measured
In the UK we use a measure called Consumer Price Index (CPI index). The method is using a fixed market basket of goods and services, this basket changes with time to reflect what people are buying in different periods of time. We also look at other factors such as taxation for alcohol and tobacco products to account for their impacts on consumer behaviour and inflation rates.
Unexpected events that can impact Inflation
There are some events that can cause changes in CPI. For example, natural disasters like a Hurricane or Tsunami which have caused an increase in inflation by driving up the cost of construction materials and oil. The government responds to these events by increasing the money supply through programs like quantitative easing where money is injected into the economy to stimulate economic activity.
