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By the end of these notes, you should be able to:
Inflation is a sustained (ongoing) increase in the general price level of an economy over a period of time.
A few important things to note:
Example: If a basket of common goods costs USD 100 in January and USD 107 in December of the same year, the economy has experienced 7% inflation.
Types of inflation by severity:
| Type | Rate | What it means |
|---|---|---|
| Creeping inflation | 1–5% (ideally 2–3%) | Low, manageable inflation — generally considered healthy |
| Running inflation | Double-digit (e.g. 10%+) | Higher and more damaging to the economy |
| Hyperinflation | 100% or more | Extreme inflation where money almost loses its value entirely |
Point 1: If inflation is at a constant rate (e.g. 3% every year), prices are NOT staying the same — they are still rising, just at a steady pace.
Point 2: During disinflation (when inflation is falling, e.g. from 7% to 2%), prices are NOT falling — they are still going up, just more slowly than before.
Point 3: Prices only actually fall when the inflation rate becomes negative — that is called deflation.
Deflation is when the general price level decreases over time — in other words, the inflation rate becomes negative.
Example: If the inflation rate is −2%, prices across the economy are falling by 2%.
Deflation is not always a good thing. There are two types:
| Good Deflation | Bad Deflation |
|---|---|
| Caused by an increase in aggregate supply (more production capacity) | Caused by a decrease in aggregate demand (people spending less) |
| Prices fall while output and productivity rise | Spending falls → firms earn less → they hire fewer workers → unemployment rises |
| Rare; associated with technological progress | Can trigger a recession (fall in national output) |
| Supply-side policies can cause this | Government tries to fix it with lower taxes or lower interest rates |
Simple Example of Bad Deflation: During an economic crisis, people panic and stop spending. Shops can't sell their goods, so they cut prices to attract buyers. Firms make less profit, lay off workers, and the cycle worsens.
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