What is Inflation?
Inflation is a rise in the general price level in an economy, sustained over time.
'Sustained' means that inflation is not a one off rise in the general price level, but a more persistent increase in prices.
Deflation is a fall in the general level of prices in an economy, sustained over time.
What causes inflation?
Demand Pull Inflation
'Too much money chasing too few goods'. Inflation can occur when there is an increase in aggregate demand in an economy.
Inflation can occur when aggregate supply in an economy decreases because firms costs rise so their prices must rise and the average price rises.
Is inflation a problem?
- Inflation is bad for savers because the value of money falls with inflation and the money you saved cannot buy as much in the future.
- Inflation is good for borrowers because the value of their debt goes down. The money they initially borrowed is worth less in the future.
- It means higher interest rates.The interest rate is the return on savings or cost of borrowing. If inflation goes up, interest rates go up,so the cost of borrowing goes up.
- It is bad for investment. If inflation goes up then interest rates go up, the cost of borrowing go up, firms take out less loans and investment falls. Firms cannot plan so cannot invest. Investment is money spent by firms on machinery and capital goods to produce consumer goods.
- Shoe leather costs (search costs). When inflation occurs consumers have to go from shop to shop to find out the…