Inflation definition is one of the most important concepts to be familiar with in all of economics. It is used to describe how inflation affects the value of money. In basic economic language, “inflation” is the increase in goods and services available for purchase by the public with the use of currency in a country. An increase in the total supply of money (including cash) in a country leads to increased purchases and more people are able to obtain and pay for these goods and services. On the other hand, if the government decides to decrease the total supply of money, this leads to less purchasing power and can lead to hyper-inflation, when the value of money declines to an extraordinary degree.
In economic textbooks, inflation is usually defined as a process that is symmetrical regarding the changes in the rate of interest and price of commodities. Inflation essentially involves changes in the general level of prices of goods and services and their prices in various markets. This concept is also used in international trade. Because it is difficult to determine the precise effects of inflation on the economy of a nation, most economists try to define it using general criteria. In simple terms, inflation is considered as a rise in prices of goods and services in a given period of time, or a change in the cost of living through the increase in consumer price index (CPI).
Another term economists use in inflation definition is “hybrid inflation.” A mixture of state-induced inflation and private-sector price increases is allowed in certain circumstances. Examples of hybrid inflation are the level of real estate prices reached by the real estate bubble in the United States during the later years of the 20th century, the rapid growth of oil prices in the United States prior to the Arab Spring uprisings, and the rapid increase of Internet prices over the last decade or so. Theoretically, any change in the rate of inflation at a given point of time should be accompanied by an equal or greater rise in real estate prices. However, because market indicators fail to coincide, the theoretical prediction is sometimes broken.
The main reason why inflation definition is not simple and straightforward is that the level of inflation may differ significantly from one economic region to another. Moreover, changes in market rates or in the level of population satisfaction, which are important in defining inflation can also have unanticipated consequences on inflation rates. For instance, rapid drops in prices of oil and other essential goods can make some individuals feel uncomfortable, while others find comfort in the rise in prices of some imported commodities. All these considerations make it difficult to apply standard inflation definition across economies.
Most economic textbooks describe inflation as the increase in the general price level that is driven by increases in demand (the demand-demand concept) and supply (in the supply-demand concept). Sometimes, the terms “inflation” are used interchangeably, but they are usually used with distinct economic concepts. In the context of macro economics and micro economics, inflation is always noted as an increase in the general price level, whereas in price level theory, inflation is sometimes noted as a decrease in the level of employment and investment, and sometimes as both. For instance, in general terms, the inflation level is defined as the level of total income of the population above the level of real per capita income, i.e., total income times the level of real per capita disposable income. On the other hand, in the price level theory, inflation is measured by the change in the long-term value of the rate of exchange of certain assets and liabilities, for instance, the value of currency denominated in a particular currency against another currency.
The use of inflation definition is important in economics courses because most students are expected to be familiar with this concept in everyday terms. It is also used in economics to describe how changes in aggregate demand, including changes in output and input effects, affect the level of inflation. This is because changes in aggregate demand affect prices directly by changing the relative prices of goods and services against each other. For instance, if output rises by two percent and prices drop by two percent, the supply will increase by two percent, while the output and input changes will determine what price level is appropriate.
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