Inflation and its Measurement

Inflation absolutely sucks if you are not an economist. It is one of the most misunderstood economic terms. Inflation affects all of us, yet few of us understand what it is, how it works, how to measure it, or how to control it.

Inflation is a sustained increase in the general price level of goods and services. It is a condition of an economy in which there is too much money chasing too few goods and services. It is also considered as a rise in the general level of prices of goods and services. Inflation is often expressed as a percentage increase in the price level.

The purchasing power of the dollar has changed a lot over time. For example, in the 1970s, the average cup of coffee cost only 25 cents. However, by 2019, that same cup of coffee would cost you $1.59. In other words, you would need more money today to buy the same amount of goods as you could a while back.

When people think of inflation, they often picture a single item that has become too expensive. But inflation isn’t just about the price of one good going up. It’s about prices in general rising across an entire economy. 

How is inflation measured?

Inflation is pretty important for economists because it can act as a temperature gauge for a nation’s economy. For example, when inflation is in the two percent range, that’s generally indicative of a healthy economy.

On the other hand, if inflation starts to outpace wage growth, that can be a sign that the economy is struggling.

Five steps companies can take to adapt to inflation

  1. Reconsider other components of sales that aren’t relevant to the base price and adjust discounts and promotions as needed.
  2. Improve the science and art of pricing change. Instead of changing prices uniformly, adjust pricing strategies.
  3. Create an inflation council that can respond swiftly to client feedback to hasten decision-making.
  4. Consider options other than price to cut costs.
  5. Keep a close eye on the execution.

How inflation affects consumers and companies?

Increase in the prices of essentials like food, utilities and gas erode the purchasing power of individual households. 

Meanwhile, companies that have to pay more for their inputs face pressure to raise prices as well, which in turn affects what consumers have to pay.

What are the main causes of inflation?

  • Demand-pull When the economy’s demand for goods and services outpaces its capacity to supply them, inflation results.
  • Cost-push inflation happens when the cost of raw materials and labor drives up the cost of output goods and services.

How inflation affects pricing?

Inflation can put a lot of pressure on companies. They often have to pay more for input materials, and in order to maintain gross margins, they have to raise prices for consumers.

If price increases are not executed carefully, companies can damage customer relationships, depress sales, and hurt margins. However, if inflation is handled correctly, companies can recover the cost of inflation on a case-by-case basis, which can strengthen relationships and overall margins.

What is Deflation?

Deflation is the sustained decrease in the general price level of goods and services. Its meaning is the opposite of inflation. The price level of goods and services decreases due to reduced demand. 

Inflation happens when demand is more and supply is less, so the prices keep increasing. Deflation happens when supply is more than demand. It is a chronic economic problem. During deflation, debt becomes more expensive.

Countries like Japan, Germany and Greece are facing deflation. Due to deflation, people have to pay more to get what they want.