What is Inflation?

One of most common yet very very important topic of Macroeconomics which is also considered to be one of the fundamental economic issue that is “INFLATION”. A general definition of Inflation is

Inflation is a rise in the general Price Level

Remember, Inflation is not an increase in ALL prices rather an increase in general level of prices and costs.

Inflation Formula

We calculate inflation by taking or measuring the rate of change of Price index of one year to another.

Price Index are weighted averages of the prices of individual products

This formula depicts that the rate of inflation is basically a percentage change in the PRICE LEVEL. But the major issue is the construction of Price Indexes.

Three Parts of Inflation

Low Inflation Galloping Inflation Hyperinflation

Low Inflation

Prices Rises Slowly Prices are Predictable Single Digit Inflation In such cases, Investors trust money Also, people are willing to lend money.

Galloping Inflation

Double digit and Tripe Digit inflation Very High Inflation Countries with Weak and Poor Governments War or countries with conflict Countries going through Revolutions or Political Turmoil Iran, Brazil, Argentina, China etc In such Inflation, rapid money value loss. Money holding/transaction lessen So at low interest rates, people don’t lend money.

Hyperinflation

Prices rise to million or trillion percent per year. Creates a disastrous situation in economies. Such an example can be of Afghanistan after the Russian war where people took money in baskets and got products in hands. Real value of currency totally collapses and the transaction between debtors and creditors distorts.

An Example of Germany Hyper Inflation with reference to the Book of Samuelson and Nordhaus

(Up next: Impact of Inflation over an Economy)