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Definition of Inflation
What is Inflation
Inflation is a rise in the general levels of prices of goods and services. As inflation rises, in any country, the purchasing power of every dollar falls. This means each dollar will purchase fewer goods and services. However, this does not mean that all prices are rising.
Even during periods of rapid inflation, some prices may remain relatively constant while others fall. For example, based on finding, although during the 1970s and early 1980s, the rates of inflation was relatively high in the United States, the prices of video recorders, digital watches, and personal computers declined. Economists believed that one troublesome aspect of inflation is when prices rise unevenly, that is --- Some may spike upward; others go up slowly; while others do not rise at all.
How is Inflation Measured
Inflation is measured by what is known as the price-index( or CPI). This is numbers which government uses to report the rate of inflation each month. The CPI measures the prices of a market basket of some 300 consumer goods and services purchased by a typical urban consumer. Price index measures the general level of prices in any year relative to prices in a base period.
Although the present composition of the market basket used in the CPI was determined from a survey of the spending patterns of over 7,000 urban consumers in the 2007 - 2008 period.
Most of the specific CPI are historical, fixed-weighted price indexes. That is, the Bureau of Labor Statistics (BLS) sets the average index level based on the average price level for the 36-month period covering the years 1982 - 1984 , equal to 100.
If say 25% of consumer spending was on housing in 1982 -1984, the assumption is that 25% of spending is still on housing in 1998. The base period is changed approximately every 10 years. The idea behind the historical, fixed-weighted approach in the U.S. for example, is to measure changes in the cost of constant standard of living of Americans.
Any Changes in the CPI thus allegedly measure the rate of inflation facing all U.S. consumers.
CPI = price of 1982 -1984 market basket in specific year/price of same market basket in base period(1982-1994) x 100.
To illustrate, the consumer price index(CPI) now uses 1982-1984 as the base period, meaning that period’s price level is equal to 100. Based on finding, the 1997 price index was about 161. Thus, consumer price were 61 percent higher in 1997 than 1982-1984, so a set of goods which cost $100 in 1982-1984 cost $161 in 1997.
How to Calculate Inflation Rate
The rate of inflation for any specific year can be calculated(say,1998) by simply subtracting the previous year’s(1997)price index from that year’s(1998) index, then divide the result by the previous year’s index, and multiplying by 100 to express the result as a percentage. Let‘s look at this simple example : If the CPI was 146.5 in 1997 and 150.9 in 1998, the rate of inflation for 1998 is calculated as follows:
Rate of inflation = (150.9 - 146.5)/(146.5) x 100 = 3.0%
The Rule of 70
It’s believed that the so-called rule of 70 provides a quantitative grasp of inflation’s effect. If we divide the number 70 by the annual rate of inflation, the quotient is the number of years it takes for inflation to double the price level. The approximate number of years it will take to double price level = 70/annual % rate of inflation.
Example : A 2.5% annual rate of inflation will double the price level in about 28(70/2.5) years. Inflation of 7% per year will double the price level in about 10(70/7)years. The rule of 70 is generally applicable. You can use it, for example, to estimate how long it will take for a saving account to double.
Inflation is not unique to the United States, in fact, all industrial nations have experienced this problem. Based on a global perspective that traces the post -1986(1987- 1997) annual inflation rates of the United States, the United Kingdom, Japan, France, and Germany, the rates of inflation the United States had experienced for that period was found to be neither unusually high nor low, relative to rate of inflation in these other industrial countries. In fact, some nations have experienced double-digit, triple-digit, and sometimes even higher rates of inflation in the past.