Economic Factors - Price Changes in the Economy

Inflation
Inflation is the economic condition characterized by continuously rising prices for goods and services. As a result, the purchasing power of a country's currency deteriorates as its value decreases and interest rates rise.
What exactly causes inflation and how does it affect your investments and standard of living? See the tutorial: All About Inflation
for the answers

There are two generally recognized types of inflation: demand-pull inflation and cost-push inflation.

  • Demand-Pull Inflation: The money supply is seen as the cause of this type of inflation. In this situation, the money supply is too large when compared with the supply of produced goods in the economy. Interest rates rise as a result, making it more expensive to borrow money. As a result, the money supply begins to shrink with the drop in lending activity.

  • Cost-Push Inflation: The rising cost of raw materials used to produce goods is seen as the cause of this type of inflation. Since manufacturers now need to pay more for these materials, they raise the prices on their products to compensate. As a result, retailers must pay more for goods, so they increase prices to pass the difference on to the consumer.

Deflation
Conversely, deflation is a persistent decline in the prices of goods and services usually caused by slowing market demand with a level supply. Purchasing power increases as a result of stagnant demand, fixed-income securities become more appealing, and producers must lower their prices to compete for the limited demand.

Inflation usually has a negative effect on security prices, especially those equities that are particularly interest-rate sensitive, such as financials, smaller companies that rely on debt financing to grow, and cyclical businesses such as durable goods like heavy machinery, automobile and steel manufacturers, and other capital goods industries.

Exam Tips and Tricks
You should understand the fundamental causes and effects of both inflation and deflation. Be prepared to address the effects
of each economic environment on the price of securities and on interest rates.

Monetary Policy
Related Articles
  1. Professionals

    Is a Google Robo-Advisor on the Horizon?

  2. Professionals

    Top Strategies on How to Become a Stock Broker

  3. Professionals

    Should You Add A Securities License To Your Qualifications?

RELATED TERMS
  1. Comprehensive Automated Risk Data ...

    The Comprehensive Automated Risk Data System (CARDS) is an initiative ...
  2. Corporate Financing Committee

    A regulatory group that reviews documentation that is submitted ...
  3. Series 79

    A examination to ensure a candidate is qualified to become a ...
  4. Research Analyst

    A person who prepares investigative reports on equity securities. ...
  5. Series 34

    An exam required for individuals seeking to engage in off-exchange ...
  6. Financial Advisor

    One who provides financial advice or guidance to customers for ...

RELATED FAQS

  1. How does a broker decide which customers are eligible to open a margin account?

    Learn how brokers have the sole discretion to determine which customers can open margin accounts, and understand the rules ...
  2. What are some of the major regulatory agencies responsible for overseeing financial ...

    Discover the specific responsibilities of some of the major regulatory agencies that oversee financial institutions in the ...
  3. Why is the Nasdaq more heavily weighted to tech stocks than other stock exchanges?

    Learn how the Nasdaq attracts technology companies due to its focus on using advanced financial technology to improve the ...
  4. How are margin calls regulated by the SEC?

    Learn how FINRA and the Federal Reserve Board regulate trading in margin accounts, and see how brokers can liquidate positions ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!