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INFLATION
Mobin Shahsavari
Course 1 (Economics and management)
PHD.Z.Haroyan
Economics History / Armenians Economy
Definition of 'Inflation'
Definition: Inflation is the percentage change in the value of
the Wholesale Price Index (WPI) on a year-on year basis. It
effectively measures the change in the prices of a basket of
goods and services in a year. In India, inflation is calculated by
taking the WPI as base.
Formula for calculating Inflation=
(WPI in month of current year-WPI in same month of previous
year)
-------------------------------------------------------------------------------------- X
100
WPI in same month of previous year
Or, in other words, we would need to spend 3% more to buy the same
things we bought 12 months ago.
RPI includes housing costs such as mortgage interest payments and
council tax, whereas CPI does not.
But that only accounts for a small part of the difference between RPI and
CPI.
The main difference is caused by the fact that, although they use much of
the same data, they calculate the inflation rate using different formulae.
The one CPI uses takes into account that when prices rise, some people
will switch to products that have gone up by less.
This results in a lower CPI reading than RPI in nearly all cases.
The method used to calculate RPI is no longer considered as best
practice so it has had its national statistic status removed, although the
Office for National Statistics (ONS) still calculates it every month.
Inflation is defined as a sustained increase in the general level of prices
for goods and services. It is measured as an annual percentage increase.
As inflation rises, every dollar you own buys a smaller percentage of a
good or service.
The value of a dollar does not stay constant when there is inflation. The
value of a dollar is observed in terms of purchasing power, which is the
real, tangible goods that money can buy. When inflation goes up, there is
a decline in the purchasing power of money. For example, if the inflation
rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in
a year. After inflation, your dollar can't buy the same goods it could
beforehand.
There are several variations on inflation:
Deflation is when the general level of prices is falling. This is the opposite
of inflation.
Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to
the breakdown of a nation's monetary system. One of the most notable
examples of hyperinflation occurred in Germany in 1923, when prices
rose 2,500% in one month!
their interest rates and workers can negotiate contracts that include
automatic wage hikes as the price level goes up.
Problems arise when there is unanticipated inflation: Creditors lose and
debtors gain if the lender does not anticipate inflation correctly. For those
who borrow, this is similar to getting an interest-free loan. Uncertainty
about what will happen next makes corporations and consumers less
likely to spend. This hurts economic output in the long run. People living
off a fixed-income, such as retirees, see a decline in their purchasing
power and, consequently, their standard of living.
The entire economy must absorb repricing costs ("menu costs") as price
lists, labels, menus and more have to be updated. If the inflation rate is
greater than that of other countries, domestic products become less
competitive. People like to complain about prices going up, but they often
ignore the fact that wages should be rising as well. The question
shouldn't be whether inflation is rising, but whether it's rising at a quicker
pace than your wages.
Finally, inflation is a sign that an economy is growing. In some situations,
little inflation (or even deflation) can be just as bad as high inflation. The
lack of inflation may be an indication that the economy is weakening. As
you can see, it's not so easy to label inflation as either good or bad - it
depends on the overall economy as well as your personal situation.
Why is it important?
The data from the CPI and RPI rates are used in many ways by the
government and businesses, and play an important role in setting
economic policyz That's because the Bank of England uses inflation to
set interest rates. If the Bank's Monetary Policy Committee thinks CPI
inflation will be above 2% in the next two years or so, it may increase
interest rates to try to subdue it. Conversely if it thinks inflation is likely to
be below 2%, it may cut interest rates. That's why inflation is a crucial
factor in determining the rates banks charge for mortgages and the rates
they offer on savings accounts. It also has a direct impact on some
people's incomes. Anything that is described as index-linked rises in line
with inflation, usually as measured by the CPI or the RPI. State benefits
and many occupational pensions rise in line with CPI. Government indexlinked savings products and some train ticket prices rise in line with RPI.
The basic state pension is currently governed by the so-called triple-lock,
rising by the highest of CPI, average earnings or 2.5%. Some companies
use the level of inflation to set annual pay rises. In recent years however,
due to the effects of the recession, many pay settlements have fallen
behind price rises.
Inflation: Conclusion
After reading this tutorial, you should have some insight into inflation and
its effects. For starters, you now know that inflation isn't intrinsically good
or bad. Like so many things in life, the impact of inflation depends on your
personal situation.
Some points to remember: Inflation is a sustained increase in the general
level of prices for goods and services. When inflation goes up, there is a
decline in the purchasing power of money. Variations on inflation include
deflation, hyperinflation and stagflation. Two theories as to the cause of
inflation are demand-pull inflation and cost-push inflation. When there is
unanticipated inflation, creditors lose, people on a fixed-income lose,
"menu costs" go up, uncertainty reduces spending and exporters aren't
as competitive. Lack of inflation (or deflation) is not necessarily a good
thing. Inflation is measured with a price index. The two main groups of
price indexes that measure inflation are the Consumer Price Index and
the Producer Price Indexes. Interest rates are decided in the U.S. by the
Federal Reserve. Inflation plays a large role in the Fed's decisions
regarding interest rates. In the long term, stocks are good protection
against inflation. Inflation is a serious problem for fixed income investors.
It's important to understand the difference between nominal interest rates
1993-2015