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Inflation is the gradual loss of purchasing power over time, reflected in a broad rise in prices for goods and services. In other words, you can buy less today with the same amount of money as you could a while back. For example, in the 1970s, the average cup of coffee cost 25 cents. By 2019, it had climbed to $1.59.
Inflation isn't limited to price spikes for any single item or service. It refers to increases in prices across a sector such as retail and, ultimately, a country's economy.
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Inflation in a healthy economy is typically in the range of two percentage points.
Inflation can stimulate spending and encourage demand and productivity when it is within range. But when inflation surpasses wage growth, it can be a warning sign of a struggling economy.
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Households lose purchasing power when the prices increase for items such as food, utilities and gasoline.
Companies lose purchasing power when prices increase for inputs used in production. In response, companies typically raise the prices of their products or services to offset inflation, meaning consumers absorb price increases.
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Statistical agencies measure inflation by determining the current value of a “basket” of various household goods and services. This is referred o as a price index.
Agencies compare the value of the index over one period to another, such as month-to-month for a monthly rate of inflation or year-to-year for an annual rate of inflation.
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During inflation, companies usually pay more for input materials. To maintain gross margins, companies raise prices for consumers.
However, if price increases are not executed carefully, companies can damage customer relationships, depress sales, and hurt margins. But done right, recovering the cost of inflation on a case-by-case basis can strengthen relationships and overall margins.
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Deflation occurs when the overall level of prices in an economy declines and the purchasing power increase. It can be driven by growth in productivity and the abundance of goods and services, a decrease in demand, or a decline in the supply of money and credit.
Generally, moderate deflation enables consumers to purchase more with less money. But deflation can also signify a weakening economy and lead to recessions and depressions. In addition, during deflation, debt becomes more expensive.
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