📈 Inflation rate: The percentage change in the general price level over a period of time
🔍 What is inflation? A simple breakdown
Imagine you buy a slice of pizza every day after school. Last year it cost $2.00. This year the same slice costs $2.10. That $0.10 increase is inflation. When many things—like pizza, notebooks, and bus tickets—all rise in price together, we say the general price level is going up.
Economists track thousands of items to calculate the average price change. This average is called the inflation rate. It is usually shown as a percentage per year. For example, if the inflation rate is 2%, something that cost $100 last year now costs about $102.
There are three common causes of inflation:
- Demand-pull: Everyone wants to buy new video games, but stores can’t get enough. Prices go up.
- Cost-push: The flour for your pizza becomes more expensive, so the pizza shop raises prices.
- Built-in: Workers ask for higher wages because living costs rise. Businesses then raise prices again to pay those wages.
📊 How do we measure inflation? The CPI basket
The most famous tool to measure inflation is the Consumer Price Index (CPI)[1]. Statisticians create a "shopping basket" containing things an average family buys: food, clothes, rent, petrol, and cinema tickets. Every month they check how the total cost of this basket changes.
| Item in basket | Price last year | Price this year | Change |
|---|---|---|---|
| Loaf of bread | $2.50 | $2.60 | +4% |
| One litre petrol | $1.40 | $1.54 | +10% |
| Movie ticket | $12.00 | $12.30 | +2.5% |
💰 A real-life example: Your savings and the new smartphone
Your grandparents give you $100 for your birthday. You put it in a drawer. A year later, you want to buy a new smartphone game that costs $5. But because of inflation, the game now costs $5.15. Your $100 still has the number 100 on it, but it can buy less—its purchasing power[2] has dropped.
Now imagine you put that money in a bank account that pays 1% interest. After a year you have $101. But if inflation was 2%, you really need $102 to buy what $100 bought before. Your money grew in nominal[3] terms (the number went up), but it shrank in real[4] terms (what you can actually buy).
❓ Important Questions
Not at all! A little inflation (around 2%) is healthy. It encourages people to buy things now instead of waiting, which helps businesses and jobs. It also makes it easier for wages to rise. The problem is when inflation is too high (prices soar every month) or too low (deflation – prices fall, which can be worse).
Hyperinflation is when prices rise extremely fast, often more than 50% per month. A famous example is Zimbabwe in the late 2000s. Prices doubled almost every day. People had to carry bags of money just to buy a loaf of bread. It makes money worthless.
Central banks (like the Federal Reserve in the US) raise interest rates. When borrowing money becomes more expensive, people and businesses spend less, which slows down price increases. It's like tapping the brakes on a car that's going too fast.
📌 Footnote
[1] CPI (Consumer Price Index): A measure that examines the average change in prices paid by consumers for a basket of goods and services over time.
[2] Purchasing power: The quantity of goods and services that one unit of money can buy.
[3] Nominal value: The face value of money, not adjusted for inflation (e.g., you have $100).
[4] Real value: The value of money after adjusting for inflation (e.g., what your $100 can actually buy).