How Inflation Erodes the Value of Money

In economics, inflation is defined as the decrease in the purchasing power of money which is reflected by a general increase in the price of goods and services in an economy. 

What Is Inflation
Inflation is the rate at which the value of a currency falls or the rate at which the price for goods and services rises because of the change in the value of the currency. 

Inflation is classified into 3 types, namely:

Demand-Pull Inflation: When there is high demand for a particular commodity, the prices of the commodity tend to increase. The rising demand for the product leads to a shortage of supply. 

In order to attain equilibrium, the price of the product is increased. This rise in the cost of other goods results in Demand-Pull Inflation.

Cost-Push Inflation: The rise in the price of a commodity because of the rise in the price of the raw materials, leads to a rise in the cost of production. 

This higher cost of production decreases the production of the commodity i.e., the supply of the commodity, whereas the demand remains the same. 

This rise in the cost of raw material, in turn, results in a rise in the price of the finished goods, leading to cost-push inflation. 

               

Built-in Inflation - Built-in inflation is based on the concept of adaptive expectations. It is based on the idea that people expect current inflation rates will continue to increase in the future. 

As the price of goods and services increases, the workers and others come to expect that these prices will continue to rise in the future at a similar rate and thus they demand more costs or wages to maintain their standard of living. 

The increased wages of the worker in turn result in a higher cost of goods and services, and this wage-price spiral continues as one factor induces the other and vice-versa.

How Can We Measure Inflation?

One can measure the inflation rate in a country by using measures like the CPI-Consumer Price Index which usually measures prevailing prices for a basket of goods and services in the economy, including cars, food, recreation, and education. 

Another measure of inflation is the PPI-Producer Price Index. It reports the change in price that affects the domestic producers. 

It measures prices for products like chemical products, fuel, farm products like meats and grains, and metals. 

If there is a rise in the price of the PPI products, then Consumer products also change and this change is reflected in the Consumer Price Index too. 

How Does the Rise and Fall In Dollar Affect the Inflation
When the Dollar index increases, it makes the dollar strong and depreciates the value of the Indian rupee. A weakened rupee results in costlier imports and impacts India’s Income profitability due to increased production costs. 

An Increase in cost and the prices of goods and services leads to inflation which in turn impacts the overall GDP (Gross Domestic Product) and suffers a slowdown when the dollar strengthens.

On the other hand, for companies engaged in exports, an increasing Dollar index is favourable because they can earn a higher revenue in terms of the US Dollar.

Companies in the export sectors like the IT sector and pharmaceutical companies who export their goods and services will benefit more when the Dollar index increases and vice-versa.

How Inflation Erodes the Value of Money 

In 1970 a land worth $100000 now will cost one $25000000. Why so? It is because of the time value of money. This concept states that the sum of the money is worth now more than it will be in the future due to several factors including inflation. 

Inflation is one of the main factors that reduce the value of money over time. In simpler terms, it means that the money one has at the beginning of the year will return lesser goods and services at the end of the year. 

The necessities will cost a little higher, whereas our income remains the same. Over time we have to cut down our expenses or start investing in order to combat inflation. Investing wisely will not only help one overcome the problem of inflation, but it will also help us achieve our financial goals successfully.

Written By- Megha Jain