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What is inflation?

Have you ever been shopping and noticed that the prices of things you typically buy have gone up? If the items in your shopping basket cost $100 last year and now they cost $105, at a very basic level, that's inflation.

Prices are changing all the time, but we don't say there is inflation every time we see a price increase. Instead, we say there is inflation when the prices of many of the things we buy rise at the same time and then continue to rise. Explained another way, inflation is ongoing increases in the general price level for goods and services in an economy over time.

Prices can change for different reasons and in different ways. The prices of individual goods and services can change because the supply or demand for the items has changed. For example, the price of oranges can rise because of a frost in Florida, or the price of parking can go up during a sporting event because more people need parking spots.

These higher prices are not examples of inflation. In the first place, these higher prices probably won't last for long. The prices of oranges and parking will most likely return to where they were once the supply and demand conditions change again. In the second place, these examples are only for one or two items. Inflation involves lots of items.

So how can we tell when inflation is happening and by how much? We do so by looking at the prices of many items over time. Government statistical agencies regularly gather information about the prices of thousands of goods and services. They then organize the prices into categories such as "transportation" and "apparel," they combine the prices in each category, and they report the results in various price indexes.

Price indexes are just collections of prices. For example, some indexes contain the prices of items that consumers buy, and others contain the prices of items that businesses buy. Others contain prices only for goods, while others contain prices only for services, and so on. If the level of an index is higher now than it was a month or year ago, it tells us that the prices contained in that index are higher on average, which tells us there is inflation.

Want to keep reading get started? Learn why you should care about inflation.

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Why Should You Care about Inflation?

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