Inflation is an upward movement the average level of prices.Its opposite deflation,a downward movement in the average prices.The boundary between inflation and deflation is price stability.Prices is moving neither up or nor down.The average level of prices is called the price level.It is measured by a price index.
A price index measures the average level of prices in one period called the base period.
The Inflation rate and the price level.
The inflation rate is the percentage change in the price level.The formula for the annual inflation rate is
A common way of measuring the price level is to use the consumer price Index(CPI)
Inflation and the value of money
When inflation is present money is losing value.The value of money is the amount of goods and services that can be bought with a given amount of money falls you can not buy as many groceries with $50 this year.As last year.The rate at which the value of money falls is equal to the inflation rate.When the inflation rate is high,as it money loses it value at a rapid pace,when inflation is low the value of money falls slowly.
Inflation is a phenomenon that all countries experience,but inflation rates vary from one country to another when inflation rate differ over a prolonged period of time,the result is a change in the foreign exchange value of money.A foreign exchange rate is the rate which one country is money or currency exchange another country’s money.
Is inflation a problem?
Is it a problem if money loses its value and does so at a rate that varies from one year to describe the problem,we need to distinguish between anticipated and unanticipated inflation.
When prices are rising people are aware of the fact and have some idea about the rate at which prices are rising.The rate at which people believe that the price level is rising is called the expected inflation rate,But expectations may be right or wrong. If they turn out to the expected rate equals the expected inflation rate and inflation is anticipated.
Anticipated inflation is an inflation rate that has been correctly forecasted .To be extent,that the Inflation rate is misforecasted.It is said to be unanticipated.That is,unanticipated inflation is the part of the inflation rate that has caught people by surprise.
The problem of unanticipated inflation
With unanticipated inflation gains and losses occur because of unanticipated changes in the value of money.Money is used as measuring rod of the value of the transaction that we understake.Borrowers and lenders,workers and their employers.All make contracts in terms of money.If the value of money varies unexpectedly overtime then the amounts really paid and received differ from those that people intended to pay and receive when they signed the contracts.Measuring value with a measuring rod whose units vary is a bit like trying to measure a piece of cloth depends on how tightly the ruler is stretched.
The problem of anticipated inflation
Anticipated inflation is a problem when the inflation rate is high.At high inflation rates people know that money is losing value quickly.So they try to avoid holding on to money for too long.The inflation rate the rate at which money is losing value is part of the opportunity cost of holding money they recieved from the sale of their goods and services they pay it out in wages as quickly as possible.
High and variable Inflation
Even if inflation is reasonably well anticipated, and even if its rate is not as high as during a period of hyperinflation.It can still impose very high costs. A High and variable inflation rate causes resources to be diverted from productive activities to forecasting inflation.
It becomes more profitable to forecast the inflation rate correctly than to invent a new product.