top of page

inflation: what it is, how it's caused, and how it affects us -nev

have any of you noticed that the prices of the things you’ve always bought have been much more expensive recently? i had this reckoning a couple of months ago when i went to starbucks to buy some cake pops (a chocolate and a birthday cake one because the vanilla one sucks) and when i went up to the register i was charged $1.95 for each pop. as i paid for them, i was still thinking about the current price of the cake pops. “in eighth grade i was paying $0.95 per cake pop, what happened??”

there are three types of inflation that are named after how they inflate prices: demand-pull inflation, cost-push inflation, and built-in inflation. the root of all of these is the increase in overall money supply across your country, and the decrease in purchasing power drives inflation through these three mechanisms. 

the main way economists measure changes in price levels is the consumer price index. the CPI is calculated by taking price changes for each item in the “basket of goods” and averaging them based on their relative prices (usually from a past month or year). you can use this CPI to find the percent of the inflation rate by dividing your current CPI value by your initial CPI value and multiplying by 100. inflation is not necessarily good or bad! too much inflation is generally considered negative for an economy, but too little inflation can be considered harmful as well. most economists would agree for around 2% inflation as the middle-ground of a stable economy. different countries have different ideal levels of inflation, but hyperinflation (often described as a period of inflation of 50% or more) can cause catastrophic economic activity and debt by decreasing the value of the currency in whichever country experiences it. 

inflation is what happened. inflation is the general rise in prices, as clearly shown through my increasingly expensive starbucks snacks. it is also defined as the decline of purchasing power of a given currency over time. a given currency refers to your unit of money, from u.s. dollars to euros and purchasing power refers to the amount of stuff, or goods, that your money can buy. this power is shown through my starbucks visit: in eighth grade, $2 could buy me two cake pops, this year it could only buy me one. essentially, the general rise in prices causes your money to be able to purchase less than it used to. 

the first kind of inflation is called demand-pull inflation. this occurs when the supply of money and credit increases the overall demand for goods and services in an economy faster than the economy can produce those goods and services. here’s an isolated analogy: imagine you’re at the only nike store releasing an exclusive new pair of air jordans and there is a line of 100 people including you. all of you are so excited for the new shoes that you guys will pay almost any price to buy them. the nike store knows that there are a lot of customers willing to pay more than the original price for these shoes because they are in high demand, so they increase the price to $250 dollars. the demand curve has increased, which increases the quantity of shoes made and sold (since so many people want them) and the price (because the demand is high so the companies can make more money off of their hot new product). this is a hypothetical situation of demand-pull inflation where higher prices were placed to satisfy the demand for a product that is increasingly becoming popular. this can also happen with an fixed supply of shoes, where more demand causes nike to rise the prices, but the supply stays the same. often, the price can jump to higher levels than the first example, since there are not any extra pairs to go around.  printing more money is also an example of demand-pull inflation. if the federal reserve printed a lot of money and distributed it to all the people who wanted the jordans, nike would know that everyone is a little bit richer, and can charge more for the shoes since they know everyone can pay that extra money.

the opposite of inflation, when prices decrease, is called deflation. an easy way to remember inflation and deflation is by blowing up an imaginary balloon in your head. if you inflate the balloon with helium, it’s going to rise off the ground in the same way prices rise with inflation. if you deflate the balloon and take out the helium, it’s not going to be able to float anymore, and it’s going to fall back to the ground in the same way prices fall during periods of deflation. 

the second type of inflation is called cost-push inflation. this occurs when the prices of inputs, or materials needed to produce the supply, increase. this can often happen during a negative economic shock, where prices around the world for a certain intermediate good rise. using the nike example again, let’s say the price of the rubber used to make the jordans increased a lot because the scarcity of it increased. nike needs to still make money off of their sales for the jordans, so they need to raise the prices of the jordans to make up for the added price in the production. therefore, when supply prices increase, the product prices have to increase too.
     the third and last type of inflation is called built-in inflation. the name refers to adaptive expectations: people are expected current inflation rates to continue in the future. when workers and others expect that prices are going to keep rising, they will demand more costs or wages to be able to keep their standard of living. their increased wages increase prices because they increase the costs of goods and services, which continues inflation. 

that’s it for my basic (and long) summary of inflation! i hope this simplified it enough for you guys to understand its basic concept, and i can post more about how it is currently affecting our economy during the pandemic. bye!! <3



bottom of page