What is Inflation?

In economics, inflation is a measure of rising prices of goods and services in an economy, which often leads to a decline in the purchasing power of the economy's local currency.

Put simply, inflation means that the same unit of currency used to purchase a basket of items today will only be able to purchase fewer items over time due to rising prices.

Check out the table below to see how prices for certain items have changed between 1960 and 2021 in the United States:

A popular metric to measure inflation is the Consumer Price Index (CPI), which is calculated by the Bureau of Labor Statistics (BLS) and examines the weighted average of various price baskets of goods and services used by specific groups of households for daily living. These baskets include food, shelter, transportation, doctors’ and dentists’ services or drugs, and are categorized differently for people living in rural or urban settings.

It is worth noting that the CPI can be a controversial index, as the exact methodology and data used to calculate CPI is not publicly available. Further, many believe that this methodology does not accurately measure inflation across the country and economy, as epitomized by the ever increasing cost of housing, healthcare, and education. Adding to this, the method for calculating CPI has also undergone more than 20 changes over the past several decades, adding to the narrative that it is not an accurate measure of inflation.

Demand-Pull Effect

Demand-pull inflation occurs when consumer demand for goods outpaces the supply available, pushing the prices of said supply up. 

This effect tends to occur when there is an increase in the supply of money and credit available to consumers, often resulting from employment increase in an economy or a government spending money more freely. 

Cost-Push Effect

The cost-push effect is when the price of goods increase as a result of production costs, which includes raw materials and employee wages. 

For the prices to increase, demand for the product must remain steady as the production cost for said product keeps increasing. 

Built-in Inflation (or Wage Push Inflation)

Build-in inflation occurs with the idea that people expect inflation rates to continue, particularly with the Federal Reserve’s target of keeping a 2% inflation rate per year. 

With this expectation in mind, there is an increase in wages across industries, which increases consumption rates, further pushing prices of goods and services up. 

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