Santhosh · created · flag · 3

Inflation refers to an increase in the level of prices of goods and services in an economy. When the supply of money goes up faster than the real output of the economy, then it will generally increase the level of prices.

Inflation can also be caused by supply shocks. When the supply of a particular product becomes scarce, its demand will increase and its price will go up.

Scenario 1: When a government prints more money, banks will start lending more money, this will increase the amount of cash circulating in the economy. When people have more money in hand, their buying power will increase. Consumers are able to demand more goods than they normally do, but companies will still have the same amount of goods. Companies will respond by increasing the prices of their goods and services.

When inflation is too high, especially in a hyperinflated economy, people will stop using their currency altogether. Instead, people will swap goods for other goods or ask to be paid in other currencies like dollars, euros, etc. That’s what happened in Venezuela, Zimbabwe, and other countries that were hit by hyperinflation.

To keep the inflation in check, the money supply must increase at the same rate as real output of the economy, then prices will stay the same.

Scenario 2: An increase in oil price increases the cost of transporting a product from production to your nearest retail outlet. This will increase the price of that chocolate you regularly buy from the grocery store.