Measuring Inflation

Price Levels of Goods and Services
Price Levels of Goods and Services

Inflation measures the change in the price levels of goods and services in an economy over time.

Inflation is defined as a sustained increase in the general level of prices for goods and services in a country, and is measured as an annual percentage change.

Under conditions of inflation, the prices of things rise over time.

Put differently, as inflation rises, every “dollar” you own buys a smaller percentage of a good or service.

When prices rise, and alternatively when the value of money falls you have inflation.

Inflation can be caused for a number of reasons, but what is important to understand is that a rate of inflation that is too high or too low is bad for economic stability.

Typically, an inflation rate between one and four percent annually is ideal.

If inflation rises too high, the prices of things in an economy can surge even if wages don’t catch up.


In extreme cases, hyperinflation can wreck a nation’s economy.

At the same time, if price levels decline, in what is known as deflation, people may stop spending money and companies may halt investments.

They anticipate that things will be cheaper tomorrow, so why spend today?

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This mindset can lead to a dangerous deflationary spiral that can also wreck an economy.

Measuring inflation is a difficult problem for government statisticians.