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The Fundamentals of Inflation

Both money and economics, grouped together, are perhaps the single most important aspect of most people’s everyday life – especially when it comes to business. No matter what a business’s specialities are, its goal is always to earn more and more money so that it can grow larger and become greater.  

As much as we try to deny it, money sometimes does make the world go round – figuratively speaking anyway.  Money is vital to our everyday capitalist economy. With it, it seems that we have far more power to use it as a tool in order to live a better lifestyle. 

While money may not necessarily bring us happiness, it certainly does give us a sense of freedom and choice, which we should rely on at any given time. 

Emersed into a world that has been dictated by the use of currency for centuries, there are quite possibly some economical terminologies that you may be unfamiliar with and often left feeling baffled when having heard of them – ‘mortgage’ being one of them.  

You’re very likely to have heard of terms such as investment; depreciation; surplus; and even yield. However, one that must not be overlooked is none other than the term inflation. 

person analyzing his business financial data
How does inflation affect my business?

What is inflation? 

Inflation can generally be defined as the rise in the level of prices. It does not matter what the item or thing in question is; whether it’s a product, service, gas, or even electricity, inflation applies to everything that money will go towards. Essentially, if you can buy it using money, its cost has the potential to either inflate or deflate in price. 

Inflation can occur in two different ways: 

  • Open inflation – Where there is a rise in the cost or price of a product or service. This type of inflation is often dependent on the community’s demand and not controlled by any form of authority such as the government. The economy will still continue to rise.  
  • Repressed inflation – or, suppressed inflation, essentially is the opposite to open inflation. This is where there is an excess demand for goods and services but prices are too low and there is little availability. This will lead to an increase in prices because of these factors.  

A prime example of repressed inflation would be the current 2021 fuel shortages in the UK. Through Brexit and the global pandemic, a lack of EU truck drivers has led to fuel shortages. In effect, demand has risen and so have fuel costs.  

How does inflation work? 

The process of inflation can be explained rather simply with the example below: 

Let’s pretend that a tin of soup is normally priced at £1. However, recently the price has now increased by 10p, the new cost for a tin of soup will now be £1.10. 

This is a classic example of how inflation happens resulting in a price increase of 10%. As time passes, the inflation rate will increase – however, it does not mean that it will consistently increase by 10% each time; the inflation percentage can vary. 

In the UK, it’s reported that the inflation rate for food items is at its highest in almost a whole decade. In July 2021 the inflation rate was at 2% and in September 2021 it has risen to 3.2%. 

It should be noted that inflation doesn’t always apply to every product or service at once; it often happens to one or two items at any given time. If multiple inflations are simultaneously taking place, not all items, products or services will have the same inflation increase. Using the example above, soup may have a hypothetical percentage increase of 10%. However, the cost of housing may have only risen by 2%. 

Inflation is often a gradual process that takes time to increase, rather than a sharp difference in price which means you aren’t too likely to feel the effects of inflation in your everyday life. 

What causes inflation? 

There are a few reasons why inflation may suddenly occur. Here are just a few of them: 

  • Increase in public spending – If the public abruptly takes an interest in a particular product or service that they’re putting their money towards, the business that sells or provides the item in question will recognise the rise in demand and decide to increase the price. In turn, inflation will occur. If there is a lack of demand for it, the price will be over time especially if – in the case of products – there is leftover and unwanted stock. This is otherwise known as deflation. 
  • Population growth – In relation to the first reason, if there are more and more people demanding the same product/service, then there’ll be an increase in prices. This will be done as a precaution since products are finite, in order to curb people from buying too much. 
  • Exports – If products are sold domestically, as well as overseas, and the overseas sales fail to meet expectations, then inflation will be increase in the domestic economy to make up for the sales loss overseas. 
  • Tax reductions – Governments may decrease tax prices on specific items and products to gain popularity from the members of the public. The public will then be pleased knowing they have more money in their possession, which will then lead to inflation caused by them spending more freely. 
  • Imposition of indirect taxes – An indirect tax is given to a business before it reaches the customer. VAT is an example of an indirect tax. This will increase costs for the business, who in turn increase the prices of their products/services even though this will have little impact on their overall profit. (Source) 

Is inflation a bad thing? 

Generally speaking, inflation is neither good nor bad, but that doesn’t mean it can’t have its problems. If inflation is high, money will lose its value, so you may find that you won’t be earning much interest on your savings in the bank. Margaret Thatcher even once said that inflation was “the unseen robber of those who have saved”. 

Conversely, if you’re experiencing debt, then you’ll find that inflation can be a good thing as the value of the debt will be low as well. When inflation occurs, it is a common conception that investing in the stock exchange can work to your advantage as often you’ll see a good return. 

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If you’re still confused or would like to know more about inflation and how it can affect you and your business, contact one of our expert advisors today at 

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