What Is Inflation?

Inflation is an increase in the average level of prices for goods and services. In other way, we can say it is an index, which shows how prices of goods and services that is representative of the economy as a whole are growing.

The immediate effect of inflation is the value of rupee/dollar (based on the country you are staying) decreases at par with inflation. That means the purchasing power of your ‘money’ decreases. If you want to understand it better, consider the below example.

Date : 31st December 2008
Price of 1KG rice : Rs 20

If the inflation raises 10% annually(i.e. if inflation throughout the year is 10% - just assume this)

Then the price of 1KG rice after 1 year(i.e on 31st December 2009) will be Rs 20 + Rs 20 * (10% of 20) = 20 + 2 = Rs 22.

That means, you need Rs 22 to buy the same 1 KG rice after 1 year just because inflation is 10% annually. In other words, you can’t buy the same 1 KG rice with your Rs 20 money anymore, which you could buy in year 2008. I.e. purchasing power of your ‘money’ got reduced.