We all have heard from our parents that a few years back, Things were so cheap. They always compare the current price of a product with old prices. The price increases and the purchasing power of a currency decreases. In India, the purchasing power of the rupee is decreasing rapidly. The reason behind it is inflation. The rate of inflation in India is above 5%. The rate of inflation should be between 2 to 3 % in a strong economy.
Inflation is when the price of a product or service increases at a higher rate than the income of an individual increase. It eventually affects the demand for products as people have less purchasing power. Usually, inflation occurs when there is an imbalance between demand and supply. When demand overlaps supply. The price of that commodity increases.
Common causes of inflation
- Demand-pull – When a seller gets to know that the demand for the product is more than the supply, they increase the price of the product to pull the demand. Increment in price will lower the demand. For example, the entry price of an amusement park is 400 rupees. The seats are limited but demand is more than the available no of entries so the price will be increased, it will eventually decrease the no. of people who are willing to buy the entry ticket.
- Cost-push – Sometimes the cost of making a product increases, So the price of the product is also increased to overcome the cost and to maintain the profit. The reason behind the increase of cost would be the increase in the cost of supply or wages of laborers or the price of raw material. The price can not be increased too high at a time so sometimes sellers adjust with less profit. For example, the price of palm oil in India increases because of government policies on import as most of the palm oil is imported from Malaysia and other countries. The cost of making chips will be higher so chip manufacturers will increase the price of chips.
- Devaluation – Devaluation is the reduction in the value of currency. It happens when the exchange rate of that currency within countries gets lower. It will make exports more expensive and imports cheaper. So demand for products from other countries will increase because of the lower value of currency. To deal with rising demand, prices are increased.
How does inflation affect consumers?
- Reduced purchasing power – An increase in price will affect the purchasing power of a currency. Inflation decreases the number of goods you can buy with your money.
- Increase spending – Inflation impacts the rise in the cost of living as they have to spend more to buy products or services due to the rise in the price of products and services. It eventually affects the reduction in saving and increment in spending. To buy the same quantity, more money will be required.
- Reduced saving – It reduces the value of saving like a person saves 1 lakh rupees for his retirement. Due to inflation, The value of 1 lakh rupees will decrease over the years and the purchasing power will be low. So that an investment is required to combat this situation.
- Wage growth – The growth in wages of employees would be done after coinciding the inflation. Otherwise, the employee will face loss and his income will increase but his standard of living will decrease as he will not be able to combat the rising cost of living.
- Impact on investment – Inflation impacts the value of investments like stocks and bonds. The investment must be done in a way that would keep up with or beat the inflation rate. If the value of an investment increases by 4% but the inflation rate increases by 5%. It means you are at a loss. Real estate and gold are good options to invest in as they are more likely to combat the rise in inflation.
- Increased interest rate – The rising rate of inflation is more likely to cause a rise in interest rate. Lenders will demand more interest rates to compensate for the loss in the purchasing power of money.
- Benefits to fixed interest rate borrowers – Inflation makes it easier to pay back the value of money which is lesser than the value of money they borrowed.
How to combat the rising rate of inflation?
- Diversification in investment – One must maintain a portfolio that can manage the value of purchasing power in such a way that he can earn profit from his investment. The combination of real estate, stock and gold makes a portfolio diversified which reduces the risk and the chances of having profit in the future become higher.
- Negotiation for lower prices – In daily life, we purchase a lot of commodities. We must negotiate to get things at a better price. This small negotiation overall impacts a lot. Streaming survival, insurance premium, and gym membership are examples of negotiation. There are always coupons and discounts available. There is no harm in asking for discounts.
- Postpone big-ticket purchases – Some commodity’s price hikes temporarily. If you are planning to buy something, and its price goes extremely high. For example, the price of phones falls after a few months of purchase. So postponement of purchase for a few months can benefit you sometimes.
There is a significant effect of inflation on the life of a person. It impacts the cost of living, savings, debts, and investments. People must be aware of how to deal with inflation to minimize the impact of inflation. Inflation can be a blessing or curse. It depends on how a person takes it. There are both advantages and losses to it.