Understanding Finance: All About Inflation

As a kid I liked to play with balloons and I used to wonder how balloons grow big when one pumps air into them. Over the years I inflated many balloons and burst almost 90% of them myself and this was my way of carrying out research on inflation. But as I grew older and my interest in economics overtook my interest in physics I came to know about the economic inflation. The powerful thing that can make or break Governments, disrupt economies and is even related to employment in some ways.

#-Link-Snipped-#So today let’s have a look at inflation. Basically inflation is nothing but increase in prices of commodities over a period of time. This upward movement of prices of goods and services is captured mathematically in percentage terms and is called as inflation. The prices of goods and services can rise because of two reasons, 1- Higher demand, and 2- lower supply.  If there is shortage of milk and you know that you may have to go without milk for days then you would be willing to pay more just to ensure that you get your quota even if it means paying more. The same would be the case if suddenly people start consuming more milk (higher demand) and there is shortage because of this increased consumption.

There is another reason for increase in prices. Which in economic terms is “Too much money chasing too few goods”. What this means is that as incomes of people grow they are willing to pay more to buy the same goods which they were buying at lower prices earlier, just to ensure that they keep getting those goods. For example, if you earn 1000 you can spend 100 on an internet connection. If the internet guy starts asking for 110 instead of 100, would you be inclined to pay? Maybe yes, or maybe no. But if you start earning 1100 you would be more inclined to pay 110 for internet connection. So as your earnings increase your inclination to spend more. Thus prices of commodities and services start going up. This is called as inflation.

Due to inflation what you can buy with 100 bucks today you may not be able to buy the same amount in future. Suppose a hot dog costs 10 bucks today in 100 bucks you can buy 10 hot dogs today, but in future, due to inflation when the price becomes 20 for a hot dog, you can buy only 5. Thus inflation reduces your purchasing power.

It also has implications on interest rates and whole host of other economic parameters. So look out for inflation, maybe tomorrow you may not be able to buy what you can with your 100 bucks today.

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