What is Inflation and How Does it Affect Professionals, Businesses, and Individuals

Inflation and What it Means for Consumers

We all would have heard the term inflation and most of us would be fretting about how the rise in prices affects our ability to spend and our rapidly shrinking disposable incomes. Inflation is the percentage increase in prices measured over a specific time period.

For instance, inflation can be calculated on a year on year basis, quarter or quarter basis and monthly as well.

There are different indices that are followed when computing inflation.

For instance, there is the WPI or the Wholesale Price Index that measures the rise in prices of commodities that are sold at the wholesaler. This means that the prices, which the consumers pay, are not part of this calculation. To get around this, there is the CPI or the Consumer Price Index, which measures the rise in prices that the consumers pay for the goods and services.

Apart from this, there is also the Workers Price Index that measures the increase in prices that the typical consumer pays.

Finally, there is the food inflation that measures the rise in food prices of a basket of commonly consumed food items. The reasons for so many indices is that price rise can happen in some specific goods and not in others.

Further, the rise in the basket of items that make up the indices is different as one cannot compare apples and oranges and hence, there needs to be a distinction between the commodities being measured.


Inflation and What it Means for Professionals

Inflation affects working professionals as it reduces their ability to spend and save. For instance, if the monthly salary is 10,000 units of whatever currency (USD etc) and the inflation is at 10% that means that the salary hike must be more than 10% if the expenditure has to remain the same.

In other words, if one spends 4000 on monthly expenditure, an inflation of 10% means that the monthly expenditure is 4400, which reduces the money available for loan repayments, savings, and other expenses. This means that the salary hike must be done accordingly as otherwise, savings and loan repayments would be hit.

Further, if one spends 6000 or more on the basket of commodities as monthly expenditure, it means that the ability to save and repay loans is curtailed even more. This is the reason why inflation is a killer for many salaried individuals and professionals who see their savings depreciating because of price rise.

Inflation and its Effect on Businesses and Economies

Inflation affects businesses and economies as well and this is because growth rates have to be more than inflation if net savings or net investments have to grow.

In other words, growth rates below the inflation level means that industry has less money left over for dividends, investments, and for growth in the next year. This is the reason the central banks’ of countries often use monetary policy that targets inflation primarily.

One possible way in which central banks’ target inflation is by keeping the interest rates high. This means that an interest rate of 11% when the inflation is at 10% means that one’s savings are growing instead of depreciating.

Further, by keeping interest rates high central banks ensure that too much money is not flooding the system by removing the incentives for individuals to borrow more.

When interest rates are high, it often results in businesses keeping the money in the banks rather than splurging on new projects. Thus means that the excess liquidity in the system is drained.

The textbook definition of inflation is that it is caused when more amount of money chases the same goods as in this case; there is more demand for the same supply of goods leading to an increase in prices.

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Managerial Economics