A Closer Look: Definition of Inflation

Here at YourDictionary, we define inflation as an increase in the amount of money and credit in relation to the supply of goods and services. Often, inflation is erroneously defined by the effect that it has on the economy. When people notice that gas, food, and lodging is getting more expensive, they often label that phenomenon inflation. Rising prices, however, are really just the result of inflation.

Monetary inflation can be thought of as the printing of money by the federal government. In earlier times, the government physically made more money and put it into circulation. In today's global economy, however, with the many types of stock exchanges, money market accounts, off-shore banks, and holding companies available, the amount of money in circulation can increase in more complex ways.

When money enters circulation at a rate that is higher than the supply of goods available, inflation is occurring. There is typically a correlation between the quantity of goods available and the amount of money in circulation. If more goods become available, more money must be put into circulation or prices will actually drop. The opposite of this, as stated above, is how economists define inflation.

When times are hard, it is often believed that those in power manipulate prices to increase their bottom lines. While there have been many instances recorded where private capitalists have engaged in price fixing and various types of collusion to falsely inflate profits, these acts are not technically related to inflation.

In theory, the free enterprise system operates on the basis of competition. Those who produce the highest goods at the most affordable prices succeed. If a company was artificially inflating its prices, theoretically, its customers would eventually take their business elsewhere. However, when seeking to define inflation, the dollar itself is worth less because the supply of dollars has increased. Businesses must then raise prices to recover their losses in an attempt to get the same value for their goods and services.