Definition of inflation and purchasing power

Summary

In economics, inflation is defined as an increase in the average price of goods and services measured in money terms. It is typically tracked using a price index such as the consumer price index (CPI). When the general price level rises, each unit of currency can buy fewer goods and services, meaning inflation corresponds to a reduction in the purchasing power of money. The opposite of inflation is deflation, which is a decrease in the general price level. Inflation is commonly summarized by the inflation rate, usually expressed as the annualized percentage change in a general price index. Because inflation reflects a broad rise in prices (not changes in any single good), it is closely tied to the value of currency over time: as purchasing power falls, consumers and workers effectively face erosion of real value unless incomes adjust.

Key Points

• 1

  Inflation is the rise in the average prices of goods and services in money terms, measured with a price index (often CPI).

• 2

  Rising general prices reduce the purchasing power of money: each unit of currency buys fewer goods and services.

• 3

  Inflation is commonly reported as the inflation rate (annualized percentage change in a general price index), and its opposite is deflation.