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Inflation
Defining Inflation
Inflation is an economic concept. Inflation basically means the rise in price of
goods and services. Since price rise affects each and every individual and can
drastically affect lives.
Type of Inflation
There are basically two main types of Inflation.
- Cost-push Inflation
- Demand Inflation (or Supply demand mismatch)
In history, an ideal example of cost-push inflation would be the oil crisis of the
1970s, which some economists see as a classic example of imported inflation
experienced in the Western world in that decade wherein price increases of a
key imported constituent impacted the price of goods across industries.
Generally the markets are most concerned with the finished goods because
these are a strong indicator of what happen with future CPI reports. Though
the CPI is a more popular measure of inflation than the WPI, investors watch
both closely. The weekly inflation numbers that are released are based on
WPI.
Inflation Baskets
CPI WPI
Food, Beverages & Tobacco Electricity for Railway Traction,
Cereals, Pulses, Oil & fats, Meat, Fish etc. Purified Terephthalic Acid (PTA)
Milk & Milk Products Injection Moulded Plastic Items
Condiment, Spices etc. Oxygen Gas in Cylinders
Vegetables, Fruits Railway Sleepers (Cement Product)
Sugar, Honey etc. Thinner
Non-Alc Beverages MS/SS Ingots
Prep. Meals etc. Cold Rolled Sheets
Pan, Supari, Tobacco etc. LPG Cylinder
Fuel & Light Jelly Filled Telephone Cables
Housing Color TV Sets
Clothing, Bedding & Foot-Wear etc. Computer &Computer based Systems
Miscellaneous Light Products
Medical Care Power, Lubricants….etc
Education Total 453 items
Recreation & Amusement
Transport & Communication
Personal Care & Effect
Household Requisites & Others….etc
Rate of Inflation
The rate of inflation is important as it represents the rate at which the real
value of an investment is eroded and the loss in spending power over time. In
other word the rate at which the prices of everything go up is called the “rate
of Inflation”.
So, when you make an investment, make sure that your rate of return on the
investment is higher than the rate of inflation in your country. In our county
India, for the year 2005-2006 the rate of inflation was 4% (Which is really low
and amazing!). This rate keeps changing every year. The finance minister
generally gives the official statement on the inflation rate of the country for a
particular year.
The required amount can be calculated using the standard future value
formula. Inflation means that over a period of time, you need more money to
fund the same expense.
Type in: = 50000*(1+5% or .05) ^ 20 and hit enter. You will get Rs.1,32,664
as the answer, which is the required amount.
If you invest Rs.100 in the market today and you make money at a 3% "rate of
return" in one year you will have Rs.103. But now, since the rate of inflation
is at 4%, an item costing Rs.100 today will cost Rs.104 a year from now. So
what you can buy with today’s Rs.100, you will only be able to buy with
Rs.104 a year from now.
But the Rs.100 that you invested has grown only at a 3% rate of return and so
it is worth Rs.103. In effect, you are loosing money!
What it means that if you had spent that Rs.1000 instead of investing, it you
would have been able to purchase a larger bundle of goods than was possible
with the Rs.1050 you earned a year later. However, this is not a suggestion
that you spend your money instead of saving it. This only highlights the fact
that your investment decision should account for the expected inflation. The
rate which one arrives at after taking inflation into account is known as the
real rate of return.
This real rate of return = Rate of expected returns – Rate of expected inflation.
The inflation rate is measured every week and announced on Thursday. Most
news publications report them on every Friday.