What is inflation?

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Inflation is defined as "a sustained increase in the general price level." The accepted method of measuring inflation is by observation of change in the Consumer price index (CPI), which is derived from movements in price of a weighted basket of common consumer goods.  

Inflation is a useful measure when considering the stability of an economy. A country with low, stable inflation is usually considered to have a stable economy, increasing confidence of businesses, who may choose to invest into more expensive labour or machinery, increasing productivity and efficiency, which may lead to higher profits. 

Consumers also benefit from low inflation, if wages are increasing at a higher rate it may inspire them to spend more, lowering the saving ratio, and causing an injection into the circular flow of income.  

The governments set a target rate of 2% for inflation in 2011. Some feel that a lower rate or even deflation may be more benificial, as consumers who observe a lower rate of inflation than wage increase will feel wealthy, however rates that are too low can effect producer confidence in the market, as profits appear to be falling due to decrease in price. This may cause them to try sell else where, reducing the total number of sales in the market, and therefore also decreasing GDP. 

 

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