Inflation
Inflation is a sustained rise in the general price level. A little is normal and even healthy; too much erodes savings and scrambles the signals prices are meant to send.
How it's measured
The Consumer Price Index (CPI) tracks the cost of a fixed basket of goods and services a typical household buys. The inflation rate is the percentage change in that index over a year. Because the basket is fixed, CPI can overstate inflation when people substitute toward cheaper goods — one reason several price indexes exist.
Demand-pull vs cost-push
- Demand-pull: total demand outruns what the economy can produce — "too much money chasing too few goods." Booms and rapid money growth are classic causes.
- Cost-push: production costs jump — an oil shock, a supply disruption — pushing prices up even without extra demand.
Why it redistributes wealth
Inflation quietly moves value around. It hurts lenders and savers holding fixed-value assets, since they're repaid in less valuable money, and helps borrowers, who repay debts with cheaper dollars. People on fixed incomes lose purchasing power. When inflation is unexpected, these transfers are largest; when it's anticipated, interest rates and contracts adjust to blunt them.
Common exam traps
- Confusing the price level with the inflation rate (a falling rate still means prices are rising).
- Mixing up inflation with a one-off relative price change.
- Forgetting the difference between nominal and real interest rates.
See how demand, money and expectations drive the price level in the simulator.
Open the inflation lab →