What is inflation? It is a continuous rise in prices.
Here’s an example: Let’s say a pizza costs Rs. 100 at the moment. If the exact same pizza costs Rs. 110 next year, we say that pizza “inflation” is 10 percent a year.
Therefore inflation, more broadly, is the rise in prices of all the goods (e.g. pizza) and services (e.g. school fees or a hair cut) in the economy.
What is the economy? Simply put, it is the money that a country makes due to the stuff that is made there by its businesses and the services that are sold there.
Why do prices go up?
- When there is more demand than supply. So if we want to consume or buy more than we produce or make, prices will go up. If we want to eat more pizza than is being made, people might have to pay more for that slice of pizza.
- When the value of the ‘input costs’ or what it takes to make the pizza, go up. Such as the cost of the pizza bread, cheese, tomatoes, vegetables, meats. Also the price of fuel for the van that brings these raw materials to the pizza parlour, and then takes the pizza out for delivery. And then of course, the poor pizza delivery person who is now delivering the pizza to 10 places rather than 5 in the same time, will also ask to be paid more.
- When these costs rise, then people who are buying the products such as the pizza also have to pay more for the same slice. So suddenly the people buying it can buy less of that product for the Rs. 100, and since their own cost of living are increasing, they ask for raises and start the whole cycle again.
Another cause of inflation: Sometimes when a country’s economy is doing poorly, its Central Bank will print too much money and then the value of that money drops.
OK so is inflation bad? In general, no. High inflation is bad, because poor people will not be able to afford anything.
The opposite of inflation is..? You guessed it! Deflation. Deflation is not good as when the prices of things fall a lot, then demand also falls. In our example with pizza – how many slices of pizza can one keep eating even if the prices fall? Companies have to cut their costs, workers don’t earn as much, and banks are not able to offer higher savings rates either.
In India, economists believe we should have inflation around 4 percent. Banks give you a rate of interest that is greater than the inflation rate if you keep your money in a savings account with them.
So the next time you buy something:
- write down its price.
- when you go back to the shop some time later, write down the price of the same good again.
- Comparing those prices, you will be able to calculate the rate of inflation!