Have you noticed an increase in gas prices in your area? Or maybe you’ve noticed an increase in the price of food?
This is called inflation.
No, not like when you blow up a balloon.
Inflation is when prices of a product or service rise due to an increase in the cost of production.
And once it starts happening in one area, people begin to fear that inflation in one sector will cause inflation in other areas.
Inflation isn’t just bad because things get more expensive. On a much larger scope of things, inflation makes your hard-earned money less valuable.
For example, if you invested in an ETF that gave you a return of 10% for the year, but inflation went up 3%, then you would have actually made a 7% increase that year.
Or worse, if you saved $5,000 this year in your savings account, inflation will make every dollar in your savings worth less. Even if you don’t touch it.
In this article we’ll discuss factors that cause inflation and how you can protect your money from it.
What causes inflation?
Let’s get down to the nitty-gritty.
Remember the concept of supply and demand?
It’s okay. Even if you forgot or if your school didn’t teach you, we’ll discuss multiple ways that the imbalance of supply and demand can affect inflation.
There are many causes of inflation and they can all be categorized into two different ways: cost push inflation and demand-puill inflation.
First, we’ll talk about these two types of inflation, and then we’ll discuss a few different real world examples that can lead to either of these two types.
This is when the cost of production becomes too expensive causing inflation in
products and services.
For example, if an agricultural farmer is selling strawberries and they’re experiencing a drought in their state. Then this means that they may have to pay for more water, causing them to charge more to send strawberries to grocery stores and restaurants.
A sign of cost-push inflation may be a rise in the cost of a commodity like oil or water.
And in addition to commodities, the cost of production can also increase if the cost of labor is increased.
Let’s dive deeper into some examples of cost-push inflation.
In short, devaluation is defined as the process of decreasing the value of a country’s money in comparison to another currency. Devaluation is usually caused by the increase in the cost of imported products combined with an increase in domestic demand.
In simple English, devaluation is caused when more people are buying imported products even though they are more expensive.
Higher wages mean companies are paying more to their workers. And as a result, workers also have more money to spend. BUT the companies that consumers are buying from are now charging more so they can pay their employees more. Kinda like a cycle that just makes things more expensive, but consumers are able to afford it because they’re being paid more.
Expectations of inflation
Many experts say that the fear of inflation can cause inflation because workers will demand higher wages to combat inflation. And if companies grant their workers higher wages on a mass level, this can result in charging more for consumer products.
For example, let’s say Coca-Cola has 50,000 employees. Maybe Coca-Cola workers fear that inflation is coming. So they go on strike or simply ask for a bonus in their salaries.
If Coca-Cola pays their employees more, then they have officially increased their cost of production - making Coke products more expensive.
This occurs when there’s a dramatic increase in the demand for a certain product or service. If the demand is greater than the supply, then that product or service will rise in price.
A good example of demand-pull inflation can be seen in sports tickets. Before Lebron James joined the Lakers, you could get a nose bleed ticket to watch the Lakers for $40. But now that Lebron is on the team, the cheapest tickets are about $90 each because more people want to see him. That’s a huge difference in price just because of an increase in demand! You can also see this happen to concert tickets when an artist becomes more famous over the years.