Inflation is the state of continuous increase in the average price of goods and services used by the general public. This means that if only the price of some goods or services increases, it is not called inflation. For this, the overall price level should have increased. Even if the prices of some have gone down, the prices of most goods and services have gone up and if such growth has continued, then the situation is called inflation.
If the production or size of goods and services does not increase with the increase in the amount of money in the market, then the purchasing power of money decreases and this condition is called inflation. In other words, inflation is the increase in the price of goods and the decrease in the value of money (purchasing power). In such a case, as the goods are expensive, a lot of money has to be spent even for small items. In general, an increase in the amount of money alone will not lead to inflation. This means that inflation can occur for a variety of reasons other than an increase in the amount of money. If production increases at the same rate or at the same rate as the price rises, then inflation may not occur. The situation of inflation is created only when the monetary income (flow) growth rate is higher than that of production.
Reasons for inflation:
Demand-driven inflation (increase in monetary income)
As monetary income increases, so does the demand for goods and services. However, if production does not increase at that rate, inflation will occur. This is called demand-driven inflation because of the increase in demand. Under normal circumstances this condition is created due to the following reasons.
A) Increase in the supply of initial currency issued by the central bank and credit money created by banks.
B) Government finance system of deficit
C) Population growth
D) Tax deduction
E) High growth in foreign debt, investment, aid and remittance income
Cost Rising Inflation (Rising Product Costs)
As the cost of production increases, so do the prices of goods and services. If inflation is created due to an imbalance between supply and demand after a slight decrease in demand due to price rise, it is called cost increase inflation. This condition is usually caused by:
A) Increase in capital cost
B) Increase in the price of raw materials
C) Increase in interest rates
D) Increase in wage rate
E) Natural disasters etc.
Impact of Inflation on Investors:
Investors with limited incomes do not want to take big risks as high inflation will reduce consumer purchasing power. Similarly, high-income investors are reluctant to invest in the face of inflation.
As the value of money decreases in the event of inflation, the value of the money saved will decline. It may not encourage people to save.
Generally, when inflation is high, interest rates are high and when they are low, interest rates are low. Therefore, in the event of inflation, investors are reluctant to look for insufficient investment sources or to make new investments. In the event of inflation, the value of the currency declines. Therefore, investors need to spend large sums of money to build a small portfolio.