Economic factors: inflation

Inflation: An increase in the general level of prices within an economy

The rate of inflation is measured using price indices. One way to understand a price index is to think of a very large shopping basket containing all the goods and services bought by households. The price index estimates changes to the total cost of this basket. CPI is a measure of consumer price inflation produced to international standards. It is the inflation measure currently used in the government's target for inflation. it is also used for purposes such as benefits.

Real income measures what you can buy with your income. If price increase by 2% over a year and your money income also increases by2% over the same period, then your real income has remained the same. Thus real income increases only if the nominal value of income rises by more than the rate of inflation over the same period. 

Causes of inflation: in general the causes of inflation can be divided into two types: 

• Cost-Push Inflation: this occurs when there is an increase in the cost of production that forces firm to increase their prices in order to protect their profit margins. This could be due to trade unions achieving wage increases etc
• Demand-Pull Inflation: is the process by which price rise because there is excess demand in the economy. Just as an increase in demand for a particular product might lead to an increase in its price unless there is a corresponding increase in supply, so demand-pull inflation can be explained as a situation when aggregate demand in the economy increases without a corresponding increase in the aggregate supply of goods in the economy 
• Inflationary expectations are views about what will happen to the rate of inflation in the future. As a result of inflationary expectations, people expect a period of rising inflation to continue into the future

In practice, the cause of inflation is difficult to disentangle. As prices rises, workers and their trade unions may try to negotiate wage increases to maintain…