Inflation and Business

Inflation is a sustained increase in the average price level of an economy.

The rate of inflation is measured by the annual percentage change in the level of prices. In the UK this is most commonly measured by the consumer price index.

Consumer Price Index (CPI) - Key Points

• The main measure of inflation for the UK
• The Government has set the Bank of England a target for inflation (using the CPI) of 2%
• The aim of this target is to achieve a sustained period of low and stable inflation
• Low inflation is also known as price stability
• Inflation has remained at a relatively low level in the UK in recent years

Effect of Inflation on Consumers

• As prices rise (inflation) money loses its value and people lose confidence in money as the value of savings is reduced
• Inflation can get out of control - price increases lead to higher wage demands as people try to maintain their living standards
• Consumers on fixed incomes (e.g. pensioners) lose out because the their real incomes fall

Effects of Inflation on Businesses

Positive effects

• Industry-wide price rises enable revenues to grow
• Growing revenues + constant gross margin = higher gross profit
• Makes using debt as a source of finance cheaper in real terms

Negative effects

• If costs are rising due to inflation, a business may not be able to pass them onto customers (PED)
• Inflation can disrupt business planning and lead to lower investment
• Rising inflation is associated with higher interest rates - this reduces economic growth and can lead to a recession