Let’s Understand Inflation

“Inflation is a phenomenon that is caused by the interplay of demand/supply of goods/services and the amount of money available. ”

To put in simple words, Inflation is the increase in average prices of certain goods and services. These goods and services are those that are an indicator of the health of the economy and hence increase in their prices is considered to be a matter of grave concern, especially for the common man.

It is also very likely that some goods and services may become cheap during the period of increased inflation. But these goods and services are very few in number and are not representative of the economy.

Because inflation means the rise in prices, it’s common sense that it’s closely related to the concept and flow of money as well as is heavily influenced by the factor of demand and supply.

Let’s take an example. Suppose severe drought conditions have led to a steep downfall in the production of food grains. What would happen?

Naturally, too many people would want to secure their share of food grains. It means too many bucks would be chasing a commodity that is low in supply. Consequently, the price would rise.

On the other hand a bumper harvest often leads to fall in prices because the demand in not that strong and the farmers also want to clear off their bulging stock. This is nothing but deflation.

Here another interesting point is also worth mentioning. It’s not only the demand that creates inflation (or deflation), but the additional supply of money also has the same effect.

Now suppose, the government prints a lot of money and pumps it into the market. What would happen now? Obviously, the amount of money would become relatively greater than the amount of food grains. This is similar to the drought situation discussed above.

It is so because in the drought also case the quantity of money that was after food grains was greater than the amount of food grains.

So, we can say that Inflation is a phenomenon that is caused by the interplay of demand/supply of goods/services and the amount of money available. If the demand for money becomes less or the supply of money is increased, we would witness inflation.

Similarly, if the supply of goods and services is scarce or the demand for them witnesses a huge increase, inflation is bound to affect the economy.

Author - DeeKay

Tags - Finance, Economy

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