• Inflation is defined as a sustained increase in the general price level of goods and services in an economy over a period of time.
  • It’s measured as an annual percentage increase.

Types of Inflation

  • Demand-Pull Inflation: Occurs when demand for goods and services exceeds their supply. This typically occurs in growing economies.
  • Cost-Push Inflation: When costs of production increase, causing producers to raise prices to maintain their profit margins. This could be due to rising labour or raw materials costs.

Measuring Inflation

  • The most widely used measure is the Consumer Price Index (CPI), which compares the price of a fixed basket of goods and services with the price of the same basket in a previous period.
  • The Retail Price Index (RPI) is another measure used, which includes housing costs such as mortgage interest payments.

Causes of Inflation

  • Monetary inflation: Occurs when the money supply grows faster than the economic output.
  • Commodity price inflation: Caused by rising input prices, such as oil or food costs.
  • Built-in inflation: When businesses and people expect prices to keep rising, it can create a self-perpetuating inflation spiral.

Effects of Inflation

  • Redistribution of income: Inflation can redistribute income from savers to borrowers, as the real value of outstanding loans decreases.
  • Reduced purchasing power: With higher prices, the value of money falls, reducing consumer purchasing power.
  • Uncertainty: High inflation can create uncertainty, particularly for businesses trying to forecast their costs and revenues.

Controlling Inflation

  • Monetary policy: Central banks can use interest rates or other monetary policy tools to control inflation. An increase in interest rates can slow down the demand for goods and services.
  • Fiscal policy: Government can use its taxation and expenditure policy to control inflation, by reducing the level of demand in the economy.
  • Supply-side policies: Longer-term measures to increase productivity and efficiency can help to control inflation by increasing the supply of goods and services.

Importance of Understanding Inflation

  • Inflation is a key indicator of the state of the economy and plays a significant role in decision-making for businesses, consumers, and governments.
  • Studying inflation helps in understanding the value of money, interest rates, and general economic policy. Understanding inflation is key for macroeconomic analysis and economic forecasting.


  • Inflation measurement can be skewed by changes in quality and not just price.
  • Not all items in the economy increase by the same amount, CPI and RPI are just averages.
  • Inflation targets by central banks and governments are not always achieved, highlighting the difficulties in controlling inflation.