A nation’s inflation rate measures how prices are rising and changing over time. The government keeps track of these changes using something called a basket of goods and services that people use, a collection that is referred to as a price index. By comparing the price of that basket between two periods, statisticians can find an overall rate of inflation. In the United States, this number is known as the Consumer Price Index (CPI).
It’s important to understand what causes inflation because it can affect your personal finances and investment strategies. There are generally two types of inflation: demand-pull inflation and cost-push inflation. Demand-pull inflation is when there’s higher demand for products than the economy can produce. For example, if consumers wanted more milk but farmers didn’t have enough cows to supply it, the price of milk would rise as a result.
Cost-push inflation is when the price of input goods and services increases, causing the price of final goods and services to increase as well. When raw materials, labor, and energy costs increase for producers, they have to pass these higher costs on to consumers.
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