Inflation: The Good, the Bad and the Ugly

In the world of economics, inflation is one tricky term. Everyone knows that prices go up over time. 60 years back you could buy a loaf of bread for $0.15, which now costs around $2 - $3. However not everyone understands the forces behind inflation. So let us find out.

What is Inflation
Inflation refers to a general rise in prices for goods and services measured against a standard level of purchasing power. As inflation rises, every dollar you own buys a smaller percentage of a good or service. For example, if the inflation rate is 5% annually, a good or service costing $100 will cost $105 in a year. (Note: The goal for most developed countries has been to sustain an inflation rate of 2-3%)
There are few variations of inflation you need to know.

Deflation: When there is a general fall in prices for goods and services. This is opposite of inflation.

Hyperinflation: When there is sharp rise of inflation. This could lead to a breakdown of the monetary system.

Stagflation: When economy becomes stagnant. This could lead to high unemployment rate.

What causes Inflation ?
There is no one cause that's universally agreed upon, but at least two theories are generally accepted.

Demand Pull Inflation: If demand for goods/services is growing faster than supply, the prices will increase. This usually occurs in emerging markets/growing economies.

Cost-Push Inflation: If there is a sudden decrease in supply, the prices go up. This in turn increases the cost of doing business for most companies. To maintain their profit levels they in turn increase the price of their goods/services which would ultimately be passed on to the consumers in the form of increased prices.

How is inflation measured ?
Inflation is measured with a price index which can be thought of as a large survey. One way of measuring inflation is by comparing two sets of goods at two different times, and calculating the increase in cost. There are many measures of inflation depending on the specific circumstances. I have listed few of the widely used ones.

Consumer Price Index (CPI): Measures consumer prices from the perspective of the buyer. (For eg. prices of gas, car, food)