The currency of a country is an important indicator of how the economy of that country is doing. Sometimes, a nation’s currency can undergo a decline of the purchasing power of the currency, or value, over time due to several factors. This is called inflation; the rate a which the value of a currency decreases.
Causes of Inflation:
Why does inflation come about? The generally accepted reasons are as follows:
Demand-Pull Effect:
When an increase in the general amount of supply of currency occurs, people will be inclined to buy more goods/services because the price of such goods/services initially remains the same while people get more money. This causes an increase in the prices of the goods/services because of extremely high demand but lower supply, which comes to balances the value of the increased currency. Therefore, the general currency value is decreased because the price of goods/services everywhere is increased to account for a lacking supply.
Cost-Push Effect:
In short, the Cost-Push effect starts with a rise in the cost of raw materials and wages. This translates to a general increase in the cost of the production of goods since both workers and materials will have to be paid more to obtain. To account for this increase, the price of the produced goods will have to increase, therefore placing a burden on the customer. This is done to ensure that companies get the same level of profit for goods that have not changed in demand; simply raising the price of said goods. Therefore, the purchasing power of currency is decreased.
Aside from these two types of inflation, other causes of inflation can be a general increase in the currency supply. This can be caused by overprinting currency in hopes of being able to buy more things, which is counteracted by a decrease in purchasing power. The other reason can be a decrease in the demand for the currency, which would also result in a decreased purchasing power of the currency. While these causes may be more illogical and less realistic, they certainly have happened.
Conclusion:
Understanding how inflation works is important because it can affect many financial decisions that you will make in the future, and without investing at all, you can lose money due to inflation as the same amount of money will be worth less in the future.
Written by Brian Caballo
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