Introduction to Session 1:
Have you ever wondered why the prices of a lot of things go higher at certain times of the year or in a few years? That slow change creeps up on you as you try to purchase new items every few months. Yes, it’s common, and it happens everywhere there is anything related to purchases, exchanges and currency in general. The term for this incident is Inflation. Of course, you have heard about Inflation a couple of times, but how does it even work? How is Inflation the reason the prices of your favorite grocery items have gone higher again? This article gives a perfect explanation of Inflation and its relation to cryptocurrency.
What is Inflation?
What exactly does Inflation mean? Inflation is a term used in finance and economics as it relates to currency and finances. Inflation is an economic term used to describe the reduction and declination of the power a given currency has to purchase goods and services over time. Okay, let’s put that in simpler terms. Inflation is how the rising prices of goods and services in an economy are measured. Inflation is how the central authority of finances, in a centralized system, measures the price of goods and services as they are rising in a particular economy. In decentralized systems, inflation occurs. However, it is measured by the general market rather than a central authority. Inflation occurs on different occasions, many of which you can relate to. For instance, when the prices of certain items rise due to the increase in the production cost of the item, such as raw materials, wages and others, this is regarded as inflation. Can you see how familiar it is?
Inflation isn’t restricted to a certain part of the financial market or product or service market. Inflation can affect any goods or services. It can affect basic expenses to purchase needs such as food, medical care, utility bills and other related items. On the other hand, it can also happen regarding expenses made on regular wants such as cars, cosmetics, stationeries, jewelry pieces, and the likes. So, as much as you’d like to avoid Inflation, it is almost inevitable. Because inflation is a huge factor that can make the money you have today less valuable tomorrow, it is a major concern of the financial markets all over the world. Your purchasing power as a customer, which is visibly attached to your currency, decreases as long as inflation occurs, and this can also slow down your race to retirement. Of course, nobody likes the sound of that.
What Causes Inflation?
So, now, you know what Inflation looks like. You finally understand how these prices sometimes increase as you connect the dots. But in the process of your moment of “Eureka”, another question comes up. What causes Inflation? Why is there even any form of Inflation in the first place?
There are several factors and influences that drive the prices up, causing Inflation in an economy. However, the major root cause of Inflation is an increase in money supply. Of course, the term supply money is self-explanatory as it represents the amount of money in circulation in an economy. When this happens, there is an imbalance because as the supply of money increases, the demand decreases. Economic standards and laws have shown this clearly.
This imbalance in the economic mechanism that causes Inflation can happen in different ways. One of these ways is when the authorities in charge of finances in an economy increase the supply of money. This can happen in a number of variations. They include loaning out newly printed money into the economy through their banking systems in the form of reserve accounts credits. It can also happen in the form of printing new and more money into the economy and giving it out to the people, or by passing a law or ill to reduce the value of whatever form of money legally is the legal tender of the economy. The most common method is the one where money is loaned out as reserve account credits because it occurs due to the purchase of government bonds from these banks through the secondary market.
There are specific classifications for the causes of Inflation in the economy. These three classifications are as follows:
Built-in Inflation: Surely, you have experienced inflation a number of times in its different forms in your lifetime. Are there any times that you expect the price increase that happened during one of these inflation periods to remain and continue in the future? If that sounds familiar, this simply explains the built-in inflation. This cause of inflation is dependent on the people. It happens when they expect that the current inflation rates will continue in the economy’s future. An economic term for this is adaptive expectations. Because a lot of people are conditioned to prepare for the worst, the workers and earners in an inflated economy prepare themselves by expecting that the increase in the prices of goods and services will continue at that similar rate, as the price of services and goods keep increasing. This conditioning will now lead them to demand more costs or wages to maintain their standard of living. This back and forth leads to a wage increase, which in turn leads to an increase in the price of goods and services. This cycle, which is called the wage-price spiral, will keep going on and on as it is a cause and effect situation.
Cost-Push Effect: Producing goods and services is dependent on cost and capital. None of them will exist without these. There are times that these costs might increase due to certain changes in the economy or raw materials. This is where the cost-push effect comes in, causing inflation. This cause of inflation happens when prices that sponsor and push the prices of production of goods and services are increased. When the supply of money and credit is increased, and this is directed into a commodity or asset in the market, and then a negative shock happens to the economy right after this addition to the major commodity supply market, then the price of all the goods and services tied to that commodity increases. This works its way to increase the purchase prices for consumers, causing inflation.
Demand-Pull Effect: The demand-pull effect works to complement the cost-push effect, to cause inflation. An increase in the supply of money and credit stimulates and increases the total demand for goods and services in an economy. When the economy can’t keep up as the demand increases faster than its production capacity, this demand causes an increase in the prices of these products. Because the members of the economy have increased demand due to the fact that they have more money available, they are willing to spend more, increasing the demand and ultimately, the prices too in the process. This causes rigid supply and higher demand with a huge gap, increasing prices and causing inflation.
Key Takeaways
Inflation is why the prices of goods and services increase at certain times.
Inflation reduces the purchasing power that a certain currency has over time.
Inflation occurs due to the increase in money supply, which a couple of factors can cause.
There are three different classifications of Inflation; Demand-pull effect, Cost-pull effect and Built-in Inflation.
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