Inflation: an increase in the average price level of goods and services in a nation over time. Deflation: occurs when the average price level of goods and services decreases over time. If a certain goods/services price falls, it does not mean the country is experiencing deflation. Price index: average of prices for a selection of goods and services in a particular nation during a given nation during a given interval of time. A price index can be used to measure the changes in the price level of goods between one period of time and another. The inflation rate is the percentage change in a price index between one period of time and another. It measures the change in the average price of goods and services in a nation over time. The inflation rate can be either positive, negative, or zero. CPI: consumer price index. Demand pull inflation is when too many consumers are chasing too few goods, so the average price of goods and services in a nation rises. Demand pull inflation is illustrated by an outward shift of AD when a nation is at or near it’s full employment of output. Cost push inflation is when costs of production faced by a nation’s producers rise (due to wages, etc) so the nations short run aggregate supply curve shifts to the left and the average price level of the nation’s output rises. Cost push inflation is sometimes accompanied by stagflation: means the economy is stagnating: experiencing zero or negative economic growth. Monetarism is the school of economic thought. It argues that changes in the money supply aimed at affecting aggregate demand will only cause inflation or deflation, but no change in the level of employment in the economy. Monetarism also supports the view that the Phillips curve is vertical and the natural rate of unemployment.
“Low inflation is the main macro economic goal for most western countries. This is because there are many economic costs of high inflation” (Economicshelp.org). When prices of goods and services increase, many factors are effected, and there is a domino effect. For example, firms that produce potato chips need to buy potatoes, oil, etc to produce it. But if the price of potatoes and oil increase, then the overall price of the packaged potato chips, increase. Furthermore, if the price of labor increases for the potato firm, they are spending a greater sum of their budget. This may lead the firm into confusion about their priorities in the allocation of their money. The business cycle will be effected by the inflation, since economies rise and fall. The increase of prices may effect this cycle. A rise in inflation will decrease the aggregate demand, leading to a slower pace flow of money, and possibly unemployment.
Price stability is a situation where the price does not fluctuate, eliminating inflation and deflation. Price stability has many more benefits compared to inflation or deflation. Price stability can lead to financial stability, to individual households and firms. Price stability is important to households, because it effects the worth of their money and income. When the price of goods and services increase, the households have less money to spend on commodities. If a family goes grocery shopping in 2000, and buy food for a family of four, but goes grocery shopping in 2013, and only have enough money to buy food for three people. This is caused by price inflation. This therefore affects the aggregate demand. Inflation can also affect the unemployment level. Deflation is when prices drop, the producers tend to lose money, since the consumers are paying less for their products.