Have you ever noticed the way the price of an item will increase over time, even though you’re still getting the same product? This seems a little bogus, but can easily be explained.
The main goal of any business is to maximize its profits. It will research its market to determine a price point that proves to yield the most revenue. This point will allow the business to make a profit while still keeping prices low enough to attract customers.
Over time, as a business gains a steady clientele, they may find they can increase their profits because they know that a higher price won’t necessarily scare away its customers.
However, the price of a good or service may increase for any number of reasons. Perhaps the cost to produce a certain good has increased, and in order to retain the same level of revenue, a company must raise its prices.
Imagine that a company has hired 5,000 new workers, and in order to pay all of their wages, they must raise prices by 10 percent.
This makes sense on a small scale, but now we will examine the bigger picture: economy-wide inflation.
Inflation is defined by Merriam-Webster’s dictionary as “a continuing rise in the general price level, usually attributed to an increase in the volume of money and credit relative to available goods and services.”
Whoa, whoa, whoa. Let’s slow down.
Where is all of this extra money coming from?
Last week I spoke about Gross Domestic Product, or GDP, and how it goes hand in hand with inflation. When GDP is continually growing, we tend to see the unemployment rate go down.
During a time like this, more money is printed and a solitary dollar will buy less than it otherwise would during a time of low inflation. This is controlled by the United States Federal Reserve.
As a greater amount of people are working, a greater amount of people have more money to spend. The more spending money that people have, the less a single dollar will mean to them.
There are still the same amount of goods however, and as a result of this, prices will generally rise.
A business knows that during these times of increased money supply, a consumer is more likely to purchase goods that they may not ordinarily splurge on.
The rate of inflation is measured by dividing the current price of any given good by the price of that good in a previous year, and then multiplying that number by 100.
This resulting number is called the Consumer Price Index, or CPI, and can then be used to compare the price of a good in any other year’s CPI.
One example of how inflation can turn into a huge economic problem is the inflation rate in Germany during the 1920’s. To pay for war expenses during the First World War, Germany printed an excessive amount of money.
This caused what is called “hyperinflation.” Money in Germany became practically worthless. It was more profitable to use money as wallpaper than to actually buy wallpaper with worthless money.
A situation like this is caused by extreme inflation, and could be detrimental to a given society. Luckily, the inflation rate in The United States right now is .2%, a very healthy number as compared to before the recession of 2008 began.