What is inflation? – Small Business Trends

What exactly is inflation and how does it affect your small business? In short, inflation reflects a reduction in the purchasing power of money – a loss of real value in the medium of exchange. In this article we explain what inflation is and how you can protect yourself from its effects. Let’s start!

What is economic inflation?

Economic inflation is an increase in core prices and wages relative to a base level of prices and wages. Core inflation is the annual change in the core index, which is calculated by the Bureau of Labor Statistics. This rate does not include the volatile prices of food and energy components, so it is usually a more accurate predictor of future inflation.

What causes inflation?

There are many causes of inflation and below we discuss four of the main ones:

Cost push inflation

Cost-push inflation occurs when the prices of production inputs such as raw materials and energy rise. Companies are starting to raise prices to maintain profit margins, and this price increase is passed on to consumers.

READ MORE: Inflation is a big concern for small business owners as prices rise

Demand-pull inflation

Demand inflation occurs when there is too much money chasing too few goods. It can be caused by rapid economic growth, an increase in government spending or a reduction in taxes.

Supply-side inflation

Supply-side inflation occurs when the supply of money decreases or the demand for money increases. It can be caused by a central bank raising interest rates or by people hoarding cash.

Asset price inflation

This happens when the prices of stocks, bonds, real estate and other financial assets rise. It is often caused by easy credit conditions and can lead to an economic bubble.

How does inflation affect the economy?

It is important to know what inflation is and how it affects the economy. Below, we’ll look at five leading economic inflation indicators:

Prices rise

In general, prices rise when the demand for goods and services increases. The oil price is a good example. When global demand for oil increases, so do oil and gas prices. Fuel inflation causes energy prices to rise, which also increases the price changes of other goods and services. These higher prices mean price increases to transport goods when fuel prices are high and there is less price stability.

Interest rates are rising

To curb inflation, the Federal Reserve (the United States’ central bank) will often raise interest rates. Raising interest rates makes it more expensive for people and businesses to borrow money, which can lead to slower economic growth.

Share prices fall

When inflation rises, stock prices usually fall because investors fear that the high prices will hurt corporate profits. They also believe the Fed will raise interest rates to control inflation, making it more expensive for companies to borrow and expand.

Dollar loses value

Inflation can cause the dollar to lose value because when prices rise, the dollar’s purchasing power falls. And when the dollar’s purchasing power declines, people are less likely to want to hold onto their dollar.

Wages lag behind prices

Inflation can also cause wages to lag prices, causing people’s incomes to fail to keep up with the rising cost of living. For example, inflation can lead to a fall in the standard of living.

measure inflation

Annual inflation is the percentage change in the price index from one year to the next. The economic growth rate is the percentage change in real GDP from one year to the next. Let’s take a look at the main ways inflation is measured:

The consumer price index

The consumer price index (CPI) is the most commonly used measure of inflation. It measures the prices of a basket of goods and services purchased by households. Central banks use the CPI to help them set interest rates.

The producer price index

The Producer Price Index or PPI measures the prices that producers receive for their goods and services. It is a leading indicator of inflation and can be used to predict changes in the CPI.

The deflator of gross domestic product

The GDP deflator is a measure of the general price level in the economy. It is calculated as the ratio between nominal GDP and real GDP. The GDP deflator is a broad measure of inflation and is often used to compare inflation rates between countries.

How long does inflation last?

Inflation can last for years, or it can be a short-term problem. The 1970s were a time of high inflation in the UK and worldwide. The reasons for this were an oil crisis and high government spending. In the early 1990s, rising oil prices and the reunification of Germany led to inflation in Europe. And in 2008, the global financial crisis led to a period of high inflation in some countries, especially those with weak currencies.

How Small Business Owners Can Cope With Inflation

Economists expect consumer prices to reach an average of 6.9% by 2022. Long-term inflation expectations have an inflation target of 2.4% at some point in 2024. Here are five ways small business owners can manage inflation:

Revise your pricing strategy. Regularly review your pricing strategy to ensure that your consumer prices align with the cost of goods and services. You may need to raise prices to cover the cost of consumer price inflation. Keep an eye on your suppliers. Inflation can increase the cost of raw materials and other production costs. Keep a close eye on your supplier costs and be prepared to switch suppliers if necessary. Hedging against inflation. One way to protect your business from inflation is to hedge against it. This can be done through financial instruments such as inflation linked bonds or commodities. Increase productivity. Another way to deal with inflation is to increase productivity. This can be done by investing in new technology or by improving processes. Business diversification. By diversifying your business, you can also protect against inflation and increase your company’s money supply. This can be done by expanding into new markets or products.

Plan ahead and take the positives

Planning ahead can help your business survive and thrive during periods of high inflation. Here are five key things inflation can benefit your business:

Good for business. Inflation can be a sign of economic growth and can lead to increased demand for goods and services. Can be good for debtors. Inflation can reduce the real value of debt and make it easier to pay off. Inflation can be good for savers. Inflation can increase the real value of savings and make them grow faster. Really good for retirees. Inflation can increase the real value of pensions, allowing them to grow faster. Ideal for companies with fixed costs. Inflation can increase sales and profit margins.

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