What is Price Inflation?
Price inflation is simply an increase in the price of a good or service over time.
How Does Price Inflation Work?
The CPI measures the change in the retail prices of approximately 80,000 specific goods and services, called the market basket. An example of price inflation for a specific good could be a 4.4-pound bag of 'extra-fancy' Golden Delicious apples that represents the 'apples' category. If the price of the apples was $2 in May and $2.25 in June, we can say that the price inflation for apples is $0.25/$2.00 = 12.5%.
Why Does Price Inflation Matter?
Price inflation is a function of supply and demand: the higher the demand and the lower the supply, the more likely price inflation is. The monetary and fiscal policies of governments also have direct effects on the degree and timing of price inflation, often for entire markets but sometimes for specific goods. In turn, price inflation's fundamental relationship with supply and demand means that it directly or indirectly affects nearly every financial decision, from consumer choices to lending rates, from asset allocation to stock prices, and from accounting methods to contract language.
CPI is not the only way to measure price inflation. The Producer Price Index (PPI), for example, measures the average change in wholesale prices. Other measures include the Employment Cost Index (ECI), which measures price inflation in the labor market; the Bureau of Labor Statistics International Price Program, which measures price inflation in import and export prices; and the Gross Domestic Product Deflator (GDP Deflator), which combines prices to consumers, producers, and the government.