Inflation rate is the increase in the price of goods or services over a period of time by comparing with the purchasing power of one currency. It is the comparison of average products’ price in the market with currency purchasing power, inflation represents the price increase.
Due to lower purchasing power, then it will increase the consumer price index (CPI) as well.
Inflation shows the opposite movement between all products in the market and the money value which is called purchasing power. It is the concept in which money loses its value compare to a price increase.
To calculate the inflation rate, we use the following formula:
Inflation rate = (Current CPI – Prior CPI) / Prior CPI
- Current CPI: is the CPI at the end of this period (year).
- Prior CPI: is the CPI at the end of the last period.
For example, the ministry of commerce has collected some products’ price change over the last 3 years to calculate inflation.
|Item||Price (Year1)||Price (Year2)||Price (Year3)|
|Bread||$ 2||$ 2||$ 2.5|
|Milk||$ 5||$ 5.3||$ 5.3|
|Coffee||$ 3||$ 3||$ 3|
|Total||$ 10||$ 10.3||$ 10.8|
We can see that in the first year, we need to spend only $ 10 to purchase all three products. While we have to increase to $ 10.3 in the second year and $ 10.8 in the third year.
Inflation rate in year 1 = (10.3-10)/10 = 3%
Inflation rate in year 2 = (10.8-10.3)/10.3 = 4.8%
It shows the money is losing its purchase power, as we need to increase its amount in order to obtain the same products over time.
Cause of Inflation
|Increase of monetary supplies||When the government decides to increase the money supply in the market. People will spend more and it will decrease the value of money. It is the same as goods when the supply increase, the value decrease.|
|The decrease in interest rate||When the interest rate decrease, people will be able to borrow more money. It is cheap to acquire more money from the bank. It will encourage people to borrow money and spend it.|
|Higher Wage||When people can earn more money, they are willing to increase their spending as well.|