What You Need To Know About Inflation

Your economics A-B-C

You might have heard statements like this

or this

and found yourself what exactly is inflation?

Definition of Inflation

Inflation refers to the general and continuous increase in the prices of goods and services. This phenomenon limits the purchasing power of both individuals and businesses, as the money used to buy a commodity in the past is worth less and is insufficient to make the same purchase today. Implying that they would need to spend more money to acquire the same item.

Inflation comes from the Latin word inflatio, which means “swelling” or “puffing up.” It was first recorded in 330 BCE during the reign of Alexander the Great, a time when commodity money was used. Over time, the term inflation came to refer to the general increase in the prices of goods and services in an economy.

Types of Inflation

There are many types of inflation, but we will focus on three key ones: demand-pull inflation and cost-push inflation.

Demand-Pull Inflation

It is caused by excessive demand, which occurs when there is more demand for goods and services than the economy can produce.

A good example is the increase in airline ticket prices during the holiday season. More people want to travel home to see their families, so airlines raise prices to meet the increased demand.

This can create a financial burden on travelers, but it is a natural consequence of the free market. When demand exceeds supply, prices go up.

Cost-Push Inflation

Cost-push inflation results from rising production input costs. When the cost of producing goods increases, producers often pass this cost on to consumers. This can be seen in how fuel prices affect the cost of eggs.

While chickens don’t need fuel to lay eggs, they do need chicken feed. The cost of producing chicken feed can be affected by the price of fuel.

In a more global context, conflicts like the Ukraine-Russia war can impact prices even in countries with no direct stake in the conflict. If we import a commodity from a region affected by conflict, its price may go up, causing a chain reaction across industries.

Deflation: A Shift in Economic Trends

Now, you may wonder if the economy can ever revert to lower prices. This

situation is known as deflation, which is the decline or fall in the prices of goods and services over time. In essence, with the same amount of money you have today, you can buy more goods and services in the future. Deflation can result from various economic factors, including declining demand for goods, excess production, or increased access to credit.

Causes of Deflation

Deflation can occur for several reasons:

Decrease in Demand

When consumers cut back on their spending, companies may reduce the prices of their commodities to stimulate demand.

Increase in Productivity

If the economy produces more goods and services, prices may go down.

International Factors

Global influences, such as a reduction in commodity prices due to international developments, can also lower domestic prices.

Challenges of Deflation

While mild deflation might seem beneficial as it lowers the cost of goods and services, it’s not necessarily the most viable solution for economic growth. Deflation can lead to certain issues, including:

Hoarding

When people expect prices to fall further, they may hoard cash, which reduces economic activity.

Decline in Business Investments

Businesses may postpone new projects or hire fewer employees due to reduced prices.

Unemployment

Decreased spending and lower profits because of falling prices can lead to job losses in companies.

In summary, understanding the concepts of inflation and deflation is crucial for making informed financial decisions. Each plays a significant role in shaping economic trends and influencing consumer behavior.

How to protect yourself from inflation:

There are a number of things you can do to protect yourself from inflation. Here are a few tips:

Embrace Asset-Based Investments: Diversifying your investment portfolio with assets that tend to appreciate in value over time, such as stocks and real estate, can help you hedge against inflation. While these investments may carry some degree of risk, their long-term growth potential can outpace inflation, preserving your wealth and potentially increasing it.

Prioritize Debt Reduction: High-interest debt, such as credit card debt or personal loans, can become a significant burden when inflation is high. Prioritizing the repayment of these debts can free up more of your income to cover essential expenses and invest in inflation-resilient assets.

Enhance Your Earnings: Increasing your income is a direct way to combat the effects of inflation. Seek opportunities to negotiate a raise at your current job, explore avenues for professional development to enhance your skills and marketability, or consider starting a side hustle to supplement your income.

Practice Prudent Spending: Carefully reviewing your budget and identifying areas where you can cut back on unnecessary expenses can help you maintain your financial stability during periods of inflation. Consider switching to more affordable alternatives for groceries, utilities, and transportation. Evaluate your subscription services and eliminate any that you don’t use regularly.

Seek Professional Guidance: Consulting with a financial advisor can provide valuable insights and strategies tailored to your specific financial situation. They can help you create a comprehensive plan to manage inflation, optimize your investments, and make informed financial decisions.