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What Is Inflation?

Inflation: a sustained rise in the general level of prices, normally measured either by the consumer price index or the retail price index. 
It is also the rate at which purchasing power has fallen.

Hyperinflation: a situation in which prices are rising so rapidly that people lose confidence in money, typically hundreds or thousands of percentage price rises.

Inflation measures the rise in the general level of prices, generally over a 1-year period. Hyperinflation is extreme inflation that damages people's faith in money and hampers economic activity.

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Causes of Inflation

There are lots of different causes of inflation.

Prices automatically rise every year, by about 1-2% per year, however if it is more than 2% it is considered high.

  • Short Term causes include natural disasters and war.
  • Manufacturers and businesses raise prices as a result of shortages, this is known as cost-push inflation.
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Effects of Inflation

When there is rapid inflation, many businesses are uncertain about how costs will change and their ability to pass on rising costs of their inputs to customers. There are also extra costs associated with frequently changing price lists and with shopping around as supplier prices change.

Consumers are uncertain about what they can afford and whether thier income will keep pace with prices. With this uncertainty, consumers become more cautious with their money and so reduce their spending because they have less purchasing power because the cost of products has increased. A business will sell less items, thus having a loss, so supply for business will go down.

However, house price inflation makes people feel like they have more money as their house is worth more. This 'wealth effect' can lead to people spending more. 

Because there are two sides, it shows that during inflation there is confusion and uncertainty.

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