Inflation, What Is It? Effects On Economy Due To Inflation Rate.

 

Inflation, what is it? and Effects on economy due to inflation rate.

You may heard about inflation rate and how it related to economic factors. If you don’t know about inflation ,don’t worry I will explain you by taking examples.

What is inflation ?

Inflation is defines as the persistent rise in the price of general products like books, pens,clothes, shoes, soaps etc. which gives you an opinion in the increase of cost of living.

It results in the purchasing power of the regular goods by demanding more money. By this we can say that inflation occurs due the difference between the supply and demand of goods and services.

Let us discuss inflation rate with an example.

Your mother gave you 1000/- rupee to buy new clothes on the occasion of your birthday. you took that money and went to shopping mall where different types of clothes available.

The worker who is working in that mall show you different types of shirts and t-shirts. But you prefer the one which costs to 1000/- . by that your 20^th birthday completed.

Next year your mom again give you 1000/- rupee to buy new clothes. You went to the same shop which you prefer last year and asked the same clothes which are similar to the clothes you buy last year.

But this time the worker said that the cost has been increased by 100/- rupee and total costs to 1100/- rupee.

Here it is the increased amount on the product is due to the inflation rate.

Due to more demand on the product the price of the product get increased in order manage the supply of the product.

 

Measuring inflation rate:

The inflation rate is measured based on two indices which are useful to calculate the price changes in India – CPI (consumer price index) and WPI (wholesale price index).

CPI is used to measure the price changes in retail prices of daily goods and services consumed by households throughout India. i.e. at consumer level price changes.

WPI is used to measure the price changes in wholesale prices among the institutions and corporations , not on the consumers.

The CPI inflation rate is 5.1% during the years 2021-2022. Where as the WPI inflation rate is 10.54%.

According to RBI(Reserve Bank of India ) the CPI inflation rate 4% is good for economy. How ever it fluctuates between 2%-6%.

Hope you got an idea about inflation .

Now we see what happens to economy if the inflation rates changes .

 

Effects on economy due to inflation rate:

Effects on economy due to change in inflation rates.

Damage in purchasing power.

Unemployment .

Changes in finance money.

Effects on cost of borrowings .

 

Damage in purchasing power:

As in the example which is discussed in the starting , you are not able to buy clothes with 1000/- rupee anymore.

Instead of that you have to satisfy with the clothes which are below 1000/- or you have to convence your mother by explaining why the cost increases by explaining inflation rate changes.

By this your purchasing power get damaged.

 

Unemployment :

Basically unemployment is inversely proportional to inflation rate. i.e. as inflation increases the unemployment decreases.

Let me present you a case study.

An economist A.W. Phillips observed the wages and unemployment of different workers in different industries in great Britain from 1861 to 1957 .

He tracked the data more accurately and come a conclusion that the change is stable and inverse relation between wages and unemployment and proposed it in  the year 1958.

 

Changes in Finance money :

Inflation effects not only our daily products but also effects the money which are in banks as saving money, FDs, cash deposits , etc.

Lets see an example.

Assume that you have 100/- rupee, with that money you can buy a chair.

Suppose you put your money 100/- in bank at an interest rate of 1% . the inflation rate is 2% (lets assume).

After 1 year you decide to buy a chair and took the money from bank . you get 125/- from bank along with interest added.

You go to shop and asks for the chair which you saw last year prices to 100/- now it becomes 150/- . but you have only 125/-. You are compromised and returned to home with that 125/- rupee.

Like this the inflation effects the money which are in banks.

 

Effects the cost of borrowings :

As the inflation increases the money which you borrowed from banks or any private persons have more interest to pay.

Why because they know that due to inflation changes the money losses its power . to sustain with that inflation rate they increase the interest rates.