Reference no: EM131716814

Inflation is defined as a sustained increase in the general level of prices for goods and services in a county, and is measured as an annual percentage change. Under conditions of inflation, the prices of things rise over time. Put differently, as inflation rises, every dollar you own buys a smaller percentage of a good or service. When prices rise, and alternatively when the value of money falls you have inflation.

The value of a dollar (or any unit of money) is expressed in terms of its purchasing power, which is the amount of real, tangible goods or actual services that money can buy at a moment in time. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in a year. After inflation, your dollar does not go as far as it did in the past. This why a pack of gum cost just $0.05 in the 1940's - the price has risen, or from a different perspective, the value of the dollar has declined. In recent years, most developed countries have attempted to sustain an inflation rate of 2-3% by using monetary policy tools use by central banks. This general form of monetary policy is known as inflation targeting.

Demand-pull inflation is the most common. It's when demand for a good or service increases so much that it outstrips supply. If sellers maintain the price, they will sell out. They soon realize they now have the luxury of raising prices, creating inflation.

Five circumstances lead to demand-pull inflation. A growing economy creates inflation as people are confident and spend more. That further benefits economic growth by creating an expectation of inflation. That motivates them to buy more now to avoid further price increases. The Federal Reserve sets an inflation target to manage the public's expectation of inflation. It's at 2 percent as measured by the core inflation rate. The core rate removes the effect of seasonal food and energy increases.

Discretionary fiscal policy contributes to demand-pull inflation. The government's ability to spend more or tax less increases demand in some areas of the economy. Marketing and new technology create demand-pull inflation for products or asset classes. Is inflation desirable and what can be done to control inflation in a market economy? Inflation is desirable when it is low, because low inflation represents price stability which is perfect for productive planning and investment. There are many ways to control inflation in a market economy which varies between a Keynesian and monetarist approach. Using a Keynesian approach, the government would get involved by breaking up monopolies, regulating commodity prices, and controlling wage levels, while using a monetarist approach, the government would make changes in policy to control the amount of money in the economy (What Causes Inflation?).

2. What is the Consumer Price Index (CPI)? Consumer Price Index (CPI) is an index that tracks changes in prices for basic goods and services (What Is the Consumer Price Index?).

The CPI behavior has increased since the year 2000.