Inflation and deflation

Inflation

A continuous rise in the price of goods and services.

Consumer Price Index

The key measure of inflation- the change in the cost of buying a fixed basket of goods and services.

Deflation

A sustained drop in the price level.

Causes of inflation

- Cost-push inflation

- Demand-pull inflation

Cost-push

- Rising raw material costs, as a result of world demand for materials

- Higher wage demands

- Decreased exchange rate, increased prices of imported goods

Advantages of low rates of inflation to businesses

- Costs can be passed more easily to customers if the there is a general price inflation

- Real value of debt decreases, creating a fall in real value if liabilities

- Company's assets and capital can increase in value, making it seem more financially secure

- Inventories are bought in advance, and sold later there can be an increase in profit margin

Disadvantages of high rates of inflation to businesses

- Employees might demand higher wages

- Increased interest rates

- Consumers may become price sensitive and look for bargains

- If inflation is higher in one country than the other, then it can make a business uncompetitive internationally

- Consumers may stockpile items and cut back on non-essential item spending

- Cash flow problems may occur if businesses are unable to finance higher costs of materials and supplies

Disadvantages of deflation to businesses

- Consumers may delay purchases hoping for decrease in prices which causes a reduction in demand, and possible recession

- Businesses with long-terms debts make interest loans with money that has risen in value since the original loan was taken out

- As prices fall, the future profitability of new investment projects appears doubtful

- Inventories of materials and finished goods fall in value