What Causes Inflation?

Inflation, defined as the increase in the averageprice level of all goods and services, is often caused by changes in supply and demand on a broad scale. For example, suppose business is booming, unemployment is low, and the average workerís wages are increasing. As a result, consumers have more disposable income available and will, therefore, be able to purchase more goods and services. Average prices will tend to rise due to the increase in demand for all goods and services.

On the other hand, suppose the economy is suffering. As unemployment rises and wages remain stagnant, consumers will be unable to purchase additional goods and services. In response, producers will slow down production and raise prices in order to cut losses. In this case, average prices will rise due to a decrease in the supply of all goods and services. This can be a vicious circle.

In addition to creating higher costs for goods and services, inflation creates depreciation in currency values. As prices increase, the purchasing power of your incomeódollar for dollaródecreases; in other words, more dollars are needed to purchase the same amount of goods and services. As time goes on, one of your greatest financial challenges will be that your personal savings and investments will have to work harder to exceed inflation. Therefore, itís always important to take inflation into consideration as you save and make purchasing decisions.

 

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