What is Inflation? Meaning, Causes and Real-Life Examples

Let’s imagine that you have Rs. 100 in your pocket right now. All of a sudden you remember that with these Rs.100, last year you purchased so many commodities, like:

• Tomatoes- Rs.20/kg
• Onions- Rs.30/kg
• Coca cola- Rs.20
• Capsicum- Rs.30/kg

While walking down to the market with Rs.100 in your pocket again to buy some groceries, you notice:

• Tomatoes- Rs.40/kg
• Onions- Rs.35/kg
• Coca cola- Rs.20
• Capsicum- Rs.35/kg

You calculate the total amount and it turns out to be Rs.130! But you only got 100 in your pocket. Suddenly you realise that your Rs.100 now, purchases less as compared to what it purchased last year.

This is called Inflation- when the prices of goods and services increase over the time, and your money’s purchasing power falls.

Now imagine this happening across the whole country and not just one market- rise in petrol prices, vegetables, education, transport, movie tickets etc. Everything is getting a little costlier year by year.

This slow and steady rise in prices is inflation.

Why the knowledge of Inflation is important for the investors?

• Erodes purchasing power- If you simply keep your money in a savings account earning a low interest rate, or worse, in cash, its real value (what it can actually buy) will decline over time due to inflation. For instance, if you earn 4% interest on your savings but inflation is 6%, you're actually losing purchasing power by 2% each year.
• Influences interest rates- Central banks often raise interest rates to combat high inflation. Higher interest rates can make borrowing more expensive, impacting businesses and consumer spending and can also affect the value of existing bonds.
• Long-Term Financial Goals: Inflation significantly impacts long-term goals like retirement planning or saving for a child's education. What seems like enough money today will likely not be enough in 10, 20, or 30 years if inflation isn't accounted for in the savings plan.

How Inflation works?

Demand-Pull Inflation:

Imagine that a very popular toy becomes a must have item for every child. Parents are rushing to buy it, but there aren’t enough toys in the market to fulfil the demand. What happens? The toy store realises that even if it charges a higher price, people would be willing to pay for it because of the spike in demand. This is a simplified example of Demand-pull inflation.

So what exactly is it?

Demand-pull inflation occurs when the overall demand for goods and services in an economy grows faster than the economy's ability to produce those goods and services. Think of it as "too much money chasing too few goods."

Real life example of demand-pull inflation:

A recent real-life example of demand-pull inflation occurred after the COVID-19 pandemic. Governments provided significant stimulus (more money), while lockdowns initially restricted production (less supply).

As economies reopened, consumers, flush with savings and stimulus, surged demand for goods like electronics and home improvements. However, supply chains struggled to recover, leading to "too much money chasing too few goods."

This imbalance allowed businesses to raise prices significantly, as seen in soaring car or furniture costs, a clear instance of demand "pulling" prices higher.

Cost-push Inflation:

Hypothetically, you run a small bakery. You will need flour, sugar, eggs and electricity to bake your bread. These are the basic inputs required by you. Now, due to bad harvest the prices of wheat rise, or the cost of electricity significantly goes up due to higher fuel prices. This scenario is the core of Cost-push inflation.

So what exactly is it?

Cost-push inflation occurs when the overall prices of goods and services rise because the costs of producing those goods and services increase. It's like businesses are "pushed" to raise their prices to maintain their profit margins.

Real life example of cost-push inflation:

A clear example of cost-push inflation in India is the impact of global crude oil price fluctuations. Since India imports most of its oil, rising international crude prices directly increase fuel costs (petrol, diesel). This then pushes up transportation costs for all goods, and manufacturing costs for industries using petroleum derivatives. Businesses, facing higher input expenses, are forced to raise their product prices, leading to widespread inflation pushed by these increased production costs

Why inflation is not uniform across the sectors?

While overall inflation (like the CPI) gives an average, specific goods and services are affected differently by unique supply, demand, and cost pressures. Some sectors are very labor-intensive. If wages in those sectors rise significantly, businesses will often pass those higher costs on to consumers. Furthermore, Government policies, taxes, and regulations can disproportionately affect certain industries, leading to higher costs and prices.

Industries with rapid technological advancements and high competition, like electronics, often see prices decline or remain stable. Rapid technological advancements make production cheaper, and intense competition among manufacturers forces them to lower prices to attract customers. A TV that cost ₹50,000 five years ago might be ₹30,000 today, even if it's more advanced.

Example:

Food Prices vs. Electronics:

• Food Prices (Volatile & Often High Inflation): Food prices in India are frequently influenced by supply shocks (like unseasonal rains affecting harvests), transportation costs (linked to fuel), and government policies. When tomato or onion prices shoot up, that's a common example of sectoral inflation due to supply issues.
• Electronics (Lower or Deflationary): Electronics (like smartphones, laptops, TVs) have seen a long-term trend of falling prices for comparable features due to rapid technological innovation, economies of scale in manufacturing, and fierce global competition.

Why is this all important to you as an investor?

• Your Money's True Worth: The average inflation rate might not show how your money is truly being affected. If you're saving for something specific like your child's college education or your own future healthcare, these costs often go up much faster than average prices. Knowing this helps you save enough money because you're preparing for those specific higher price increases, not just a general number.
• Smarter Investing Choices: Since different things get more expensive at different rates, you can make smarter choices about where to put your money. If you see healthcare costs always rising, you might think about investing in healthcare companies. If you're worried about food prices jumping, you might spread your investments around so you're not overly exposed to that one area. This helps your investments keep pace with the actual costs of the things that matter most to you.

How to Measure Inflation

CPI- Consumer Price Index

CPI shows how much the cost of living has increased. It tells us the rate of inflation that affects the common people.

If CPI is 4%, it means that the things cost 4% more than what they did last year.

Let’s say:

• Milk was ₹50 per litre last year
• Now it's ₹55 per litre
  That’s a 10% increase — and this change gets captured in CPI.

If many such items go up in price, the CPI rises, and that’s how we feel inflation.

WPI- Wholesale Price Index

WPI tracks the prices of goods sold in bulk at the wholesale level, not retail.

It doesn’t care what you pay in the market. It cares about what businesses pay to other businesses for raw materials, fuel, industrial products, etc.

If WPI = 5%, that means, on average, wholesale prices have risen by 5% over the past year.

Let’s say:

• A factory used to buy 1 ton of steel for ₹50,000
• Now the same steel costs ₹55,000
  That’s a 10% increase in wholesale price and this is captured in the WPI.

Why some inflation is good for the economy?

• It Makes Us Spend and Invest: Imagine if you knew everything would be cheaper next week. You'd probably wait to buy things, right? And businesses would hold off on building new factories. A little bit of inflation (prices gently going up) pushes us to buy things now or invest our money (in stocks, property, etc.) instead of just sitting on it. This constant flow of money keeps businesses busy, helps them grow, and creates jobs, which is good for everyone.
• Helps Companies Adjust Wages Smoothly: Let’s imagine that no inflation exists in the economy and you earn Rs.50000 per month. Now, if the company is having a tough year, and they need to cut costs, they might have to say, "We need to cut everyone's salary by 5%." So, your pay goes from ₹50,000 to ₹47,500. This feels like a direct hit.

Now, imagine that there exists a little inflation of 4% per year. You’re still earning Rs.50000 per month and when the company will be having a tough year, instead of cutting your pay, they might say, "We won't be giving raises this year." So, your nominal pay (the number on your salary slip) stays at ₹50,000. 

However, because there's 4% inflation, the cost of living is going up by 4%.

This means that while you're still getting ₹50,000, that ₹50,000 can buy 4% less than it could at the start of the year. So, your real spending power has effectively gone down by 4%, even though your pay slip shows the same number.

It's smoother for companies to adjust because they don't have to announce unpopular pay cuts. They can manage their expenses without causing major employee backlash.

The Curious Case of Japan: Deflationary Pressures

Most countries, especially growing ones like India, typically worry about inflation – prices going up too quickly. Japan, however, has been stuck in the opposite predicament for decades: deflation, which is a sustained, widespread fall in prices. This makes Japan a "curious case" because its economic challenges are often the reverse of what many other nations face. 

What is Deflation?

Deflation is simply when prices for goods and services generally go down over time. It's the opposite of inflation. While falling prices might sound good at first, sustained deflation is usually bad for the economy because it makes people delay buying things (hoping prices will fall even more), businesses earn less, and debt becomes harder to pay back.

Why Japan has been battling with Deflation for decades?

• Aging and Shrinking Population: Due to the aging population in Japan, fewer young people enter the workforce which reduces the overall consumer demand(older people tend to spend less) and less need for housing and infrastructure. This consistently weighs down on demand, making it harder for prices to rise.
• Conservative consumer behaviour: After a huge property and stock market crash in the early 1990s, Japan's economy struggled for many years, a period known as its "lost decades". This made Japanese people and businesses very cautious. They got used to prices either staying the same or even falling, so they often thought, "Why buy something now if it will be cheaper later?" This habit of delaying purchases actually made prices fall further, as businesses had to cut prices to attract buyers. Companies also became afraid to invest or raise their own prices. This whole cycle of people spending less and businesses investing less led to slow economic growth and a problem called deflation, showing that too little inflation can be just as bad for an economy as too much.    

Also check - Inflation Calculator

Conclusion

Inflation isn't just an economic term used in newspapers—it's something that touches our daily lives and future goals in very real ways. From the price of onions to the cost of education, inflation directly impacts what our money can buy. A small increase in inflation each year may seem harmless, but over time, it erodes your savings, affects your lifestyle, and challenges your long-term financial plans.

For investors, ignoring inflation is like sailing without a compass. You may think you're saving or earning returns, but if inflation is outpacing those returns, your real wealth is actually shrinking. Understanding how inflation works—whether it's demand-pull or cost-push, whether it shows up in the CPI or WPI—gives you an edge. It allows you to make smarter investment choices, align your goals realistically, and choose instruments that help your money grow faster than inflation.

At the same time, it's important to know that not all inflation is bad. A healthy level of inflation keeps the economy moving—encouraging spending, investment, and business growth. But too much inflation (or deflation, like in Japan's case) can disrupt this balance and cause economic pain.

In short, inflation is a silent force that shapes economies and lives. The more you understand it, the better you can protect and grow your money. Whether you’re a student, salaried worker, business owner, or investor—keeping an eye on inflation is not optional, it’s essential.