When there is a rise in general price level for all goods and services it is known as inflation.

An
inflationary movement could be because of the rise in any single price or a group of prices of related
goods and services.

CAUSES:

Different schools of thought provide different views on what actually causes inflation.
However, there is a general agreement amongst economists that economic inflation may be
caused by either an increase in the money supply or a decrease in the quantity of goods
being supplied.

Causes OF Inflation
There are a few different reasons that can account for the inflation in our goods and services; let's
review a few of them.

 Demand-pull inflation refers to the idea that the economy actual demands more goods and
services than available. This shortage of supply enables sellers to raise prices until an
equilibrium is put in place between supply and demand.
 The cost-push theory , also known as "supply shock inflation", suggests that shortages or
shocks to the available supply of a certain good or product will cause a ripple effect through
the economy by raising prices through the supply chain from the producer to the consumer.
You can readily see this in oil markets. When OPEC reduces oil supply, prices are artificially
driven up and result in higher prices at the pump.
 Money supply plays a large role in inflationary pressure as well. Monetarist economists
believe that if the Federal Reserve does not control the money supply adequately, it may
actually grow at a rate faster than that of the potential output in the economy, or real GDP.
The belief is that this will drive up prices and hence, inflation. Low interest rates correspond
with a high levels of money supply and allow for more investment in big business and new
ideas which eventually leads to unsustainable levels of inflation as cheap money is available.
The credit crisis of 2007 is a very good example of this at work.
 Inflation can artificially be created through a circular increase in wage earners demands and
then the subsequent increase in producer costs which will drive up the prices of their goods
and services. This will then translate back into higher prices for the wage earners or
consumers. As demands go higher from each side, inflation will continue to rise.

Types of Inflation

There are four main types of inflation. The various types of inflation are briefed below.

Wage Inflation: Wage inflation is also called as demand-pull or excess demand inflation. This type of
inflation occurs when total demand for goods and services in an economy exceeds the supply of the
same. When the supply is less, the prices of these goods and services would rise, leading to a situation
called as demand-pull inflation. This type of inflation affects the market economy adversely during the
wartime.
Cost-push Inflation: As the name suggests, if there is increase in the cost of production of goods and
services, there is likely to be a forceful increase in the prices of finished goods and services. For instance,
a rise in the wages of laborers would raise the unit costs of production and this would lead to rise in prices
for the related end product. This type of inflation may or may not occur in conjunction with demand-pull
inflation.

Pricing Power Inflation: Pricing power inflation is more often called as administered price inflation. This
type of inflation occurs when the business houses and industries decide to increase the price of their
respective goods and services to increase their profit margins. A point noteworthy is pricing power
inflation does not occur at the time of financial crises and economic depression, or when there is a
downturn in the economy. This type of inflation is also called as oligopolistic inflation because oligopolies
have the power of pricing their goods and services.

Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes place when there
is an increase in the price of the goods and services produced by a certain sector of industries. For
instance, an increase in the cost of crude oil would directly affect all the other sectors, which are directly
related to the oil industry. Thus, the ever-increasing price of fuel has become an important issue related to
the economy all over the world. Take the example of aviation industry. When the price of oil increases,
the ticket fares would also go up. This would lead to a widespread inflation throughout the economy, even
though it had originated in one basic sector. If this situation occurs when there is a recession in the
economy, there would be layoffs and it would adversely affect the work force and the economy in turn.

Other Types of Inflation

Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This occurs when
there is a deficit budget. For instance, Fiscal inflation originated in the US in 1960s at the time President
Lydon Baines Johnson. America is also facing fiscal type of inflation under the presidentship of George
W. Bush due to excess spending in the defense sector.

Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation. This type of
inflation occurs during or soon after a war. This can usually lead to the complete breakdown of a country’s
monetary system. However, this type of inflation is short-lived. In 1923, in Germany, inflation rate touched
approximately 322 percent per month with October being the month of highest inflation.

To sum up, any type of inflation could affect the economy of a country badly.

Effects

General

An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when
the general level of prices rises, each monetary unit buys fewer goods and services. [28] The effect of inflation is not
distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from
this decrease in the purchasing power of money. For example, with inflation, lenders or depositors who are paid a
fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their
borrowers benefit. Individuals or institutions with cash assets will experience a decline in the purchasing power of
their holdings. Increases in payments to workers and pensioners often lag behind inflation, especially for those with
fixed payments.[10]

Increases in the price level (inflation) erodes the real value of money (the functional currency) and other items with
an underlying monetary nature (e.g. loans and bonds). However, inflation has no effect on the real value of non-
monetary items, (e.g. goods and commodities, gold, real estate).[29]

Negative
High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the
market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity
as companies are forced to shift resources away from products and services in order to focus on profit and losses
from currency inflation.[10] Uncertainty about the future purchasing power of money discourages investment and
saving.[30] And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax
rates unless the tax brackets are indexed to inflation.

With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such as some
pensioners whose pensions are not indexed to the price level, towards those with variable incomes whose earnings
may better keep pace with the inflation.[10] This redistribution of purchasing power will also occur between
international trading partners. Where fixed exchange rates are imposed, higher inflation in one economy than
another will cause the first economy's exports to become more expensive and affect the balance of trade. There can
also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable
inflation.

Cost-push inflation
High inflation can prompt employees to demand rapid wage increases, to keep up with consumer prices.
Rising wages in turn can help fuel inflation. In the case of collective bargaining, wage growth will be set as
a function of inflationary expectations, which will be higher when inflation is high. This can cause a wage
spiral.[31] In a sense, inflation begets further inflationary expectations, which beget further inflation.
Hoarding
People buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting
rid of excess cash before it is devalued, creating shortages of the hoarded objects.
Hyperinflation
If inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal
workings of the economy, hurting its ability to supply goods. Hyperinflation can lead to the abandonment
of the use of the country's currency, leading to the inefficiencies of barter.
Allocative efficiency
A change in the supply or demand for a good will normally cause its relative price to change, signalling to
buyers and sellers that they should re-allocate resources in response to the new market conditions. But
when prices are constantly changing due to inflation, price changes due to genuine relative price signals are
difficult to distinguish from price changes due to general inflation, so agents are slow to respond to them.
The result is a loss of allocative efficiency.
Shoe leather cost
High inflation increases the opportunity cost of holding cash balances and can induce people to hold a
greater portion of their assets in interest paying accounts. However, since cash is still needed in order to
carry out transactions this means that more "trips to the bank" are necessary in order to make withdrawals,
proverbially wearing out the "shoe leather" with each trip.
Menu costs
With high inflation, firms must change their prices often in order to keep up with economy-wide changes.
But often changing prices is itself a costly activity whether explicitly, as with the need to print new menus,
or implicitly.
Business cycles
According to the Austrian Business Cycle Theory, inflation sets off the business cycle. Austrian economists
hold this to be the most damaging effect of inflation. According to Austrian theory, artificially low interest
rates and the associated increase in the money supply lead to reckless, speculative borrowing, resulting in
clusters of malinvestments, which eventually have to be liquidated as they become unsustainable. [32]

Positive

Labor-market adjustments
Keynesians believe that nominal wages are slow to adjust downwards. This can lead to prolonged
disequilibrium and high unemployment in the labor market. Since inflation would lower the real wage if
nominal wages are kept constant, Keynesians argue that some inflation is good for the economy, as it
would allow labor markets to reach equilibrium faster.
Debt relief
Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate
as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the inflation rate. [dubious –
discuss]
(R=n-i) For example if you take a loan where the stated interest rate is 6% and the inflation rate is at
3%, the real interest rate that you are paying for the loan is 3%. It would also hold true that if you had a
loan at a fixed interest rate of 6% and the inflation rate jumped to 20% you would have a real interest rate
of -14%. Banks and other lenders adjust for this inflation risk either by including an inflation premium in
the costs of lending the money by creating a higher initial stated interest rate or by setting the interest at a
variable rate.
Room to maneuver
The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which
banks can borrow from the central bank, and open market operations which are the central bank's
interventions into the bonds market with the aim of affecting the nominal interest rate. If an economy finds
itself in a recession with already low, or even zero, nominal interest rates, then the bank cannot cut these
rates further (since negative nominal interest rates are impossible) in order to stimulate the economy - this
situation is known as a liquidity trap. A moderate level of inflation tends to ensure that nominal interest
rates stay sufficiently above zero so that if the need arises the bank can cut the nominal interest rate.
Tobin effect
The Nobel prize winning economist James Tobin at one point argued that a moderate level of inflation can
increase investment in an economy leading to faster growth or at least a higher steady state level of income.
This is due to the fact that inflation lowers the real return on monetary assets relative to real assets, such as
physical capital. To avoid this effect of inflation, investors would switch from holding their assets as
money (or a similar, susceptible-to-inflation, form) to investing in real capital projects. See Tobin monetary
model[33][Unclear: See Discussion]

Inflation, is an economic concept. What the cause of inflation is, is not

important to us from the point of view of this article. What is important to us

is the effect of inflation! The effect of inflation is the prices of everything

going up over the years.

A movie ticket was for a few paise in my dad’s time. Now it is worth Rs.50.

My dads first salary for the month was Rs.400 and over he years it has now

become Rs.75,000. This is what inflation is, the price of everything goes up.

Because the price goes up, the salaries go up.

If you really thing about it, inflation makes the worth of money reduce. What

you could buy in my dad’s time for Rs.10, now a days you will not be able to

buy for Rs.400 also. The worth of money has reduced! If this is still not clear

consider this, when my father was a kid, he used to get 50paise pocket
money. He used to use this money to go and watch a movie (At that time

you could watch a movie for 50paise!)

The moral of the story is that, the worth of the 50paise reduced dramatically.

50paise could buy a whole lot when my dad was a kid. Now, 50paise can

buy nothing. This is inflation. This tells us two important things.

Firstly: Do not keep your money stagnant. If you just save money by putting

it your safe it will loose value over time. If you have Rs.1000 in your safe

today and you keep it there for 10years or so, it will be worth a lot less after

10 years. If you can buy something for Rs.1000 today, you will probably

require Rs.1500 to buy it 10 years from now. So do not keep money locked

up in your safe.

Always invest money.

If you can’t think where to invest your money, then put it in a bank. Let it

grow by gaining interest. But whatever you do, do not just lock your money

up in your safe and keep it stagnant. If you do this, you will be loosing

money without even knowing it. The more money you keep stagnant the

more money you will be loosing.   

Secondly: When investing, you have to make sure that the rate of return on

your investment is higher than the rate of inflation.