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What is Inflation? How
it affects your Earning?
What
is Inflation?
Inflation is the
term used to define the general rise in level of the price of goods and services
in any economy which subsequently reduces the buying power of a currency.
The following example two examples will clarify the meaning of Inflation
1. If you were able to buy one kg of
Rice for Rs 8 to Rs 10 in 1980 then same Rice you would be able to buy at Rs. 30
to Rs 40 in 2010. So if inflation rises, each unit of currency buys fewer goods
and services.
2. My grandmother is supposed to say
that in Rs 1 they were doing shopping for a week.
Movie tickets price were Rs 2 to Rs 3 in 1980s and now they are for Rs 100 to
Rs 200.
Inflation kept on rising and the money value kept on decreasing.
Inflation has really brought the value of our hard earned money down.
How is inflation calculated?
The wholesale Price Index (WPI) is used to calculate the rate of inflation
in our economy. WPI index uses whole sale prices of products instead of retail
consumer prices.
What steps to be taken as Individual to take care of rising Inflation?
As the individual, the person need to look at investing, this can take the
impact of inflation in future.
If you invest Rs. 100 in the market today and you get 6% rate of return then at
the end of the year you will have Rs.106.
But (for example) If the rate of inflation is at 8 % then an item costing Rs.100
today will cost Rs.108 after a year. So what you can buy with todays Rs.100,
you will be able to buy with Rs. 108 after one year.
So in conclusion, the rate of return on your investments should be higher than
the rate of inflation.
Practical method to approach
If you are planning to buy a product (product can be anything) at Rs 100
today will cost Rs 108 (at the rate of 8% inflation) after one year. So instead
of Investing Rs 100 today invest more then Rs 108 today so that your investments
and returns on that can take care of the future rising inflation.
What are the causes of Inflation?
The following factors can lead to inflation:
Loose or expansionary monetary
policy - If there is a lot of money going around, then supply is
plentiful compared to the products you can buy with that money. The law of
supply and demand
therefore dictates that prices will rise.
Increases in production costs
Tax rises
Declines in exchange rates
Decreases in the availability of
limited resources such as food or oil
War or other events causing
instability
What are the effects of Inflation on an economy?
Inflation has both Negative and Positive points which are as follows.
Negative
Add inefficiencies in the market,
and make it difficult for companies to budget or plan long-term
Can impose hidden tax increases, as
inflated earnings push taxpayers into higher income tax rates.
Cost-push inflation - Rising
inflation can prompt employees to demand higher wages, to keep up
with consumer prices. Rising wages in turn can help fuel 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.
Price inflation has immense effect
on the Time Value of Money (TVM)- The above two examples
explains the meaning of this statement.
Positive
Labor-market adjustments -
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
What measures can be taken to control Inflation?
The central banks, monetary authorities or finance ministries of most
nations have the authority to take economic measures to control rising inflation
by regulating the following factors:
Reducing the central bank interest
rates and increasing bank interest rates
Regulating fixed exchange rates of
the domestic currency
Controlling prices and wages
Providing cost of living allowance
to citizens in order to create demand in the market.
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