Why do prices always go up in an economy?

If you speak to someone of the older generation, it is not long before they will start saying something like:

“When I was a lad, you could get a pint of beer for only 10p, its outrageous how much it costs these days”

Economies are more likely to experience inflation than deflation.

global-inflation-rate
Source: World Bank

Despite fall in the inflation rate, prices are still rising (prices are rising at a slower rate in 2015.

The rise in prices is partly a reflection of generally positive economic growth. As demand expands, we tend to get a moderate amount of inflation.

As prices rise the dollar or pound in your pocket buys fewer goods.

purchasing-power-of-consumer-dollar

How inflation has led to a fall in the value of the dollar – it can purchase fewer goods.

Rising prices and rising wages

Real-Wages-1855-2009

The first thing is that generally speaking, wages have increased much faster than prices. In a way, the real cost of goods has fallen. In 1945, the average wage may have been able to buy 50 pints of beer. In 2007, the average wage should be able to buy say 140 pints of beer. (Assuming that is how you wished to spend all your weekly wage)

Therefore, the rate of inflation is important, but, it is more important to know how much wages are increasing by more than prices.

However, between 2007-17, prices have risen faster than wages in the UK.

inflation-1910-2010

Secondly, prices don’t always go up. We have witnessed periods of deflation (falling prices and money increasing in value). The last period of deflation in the UK was during the 1920s and 1930s. Of course, this was mainly a period of economic depression. Falling prices are often associated with falling output. – Firms can’t sell goods so they have an incentive to cut prices. In recent times, Japan experienced deflation during the 1990s and early 2000s. However, again these periods of deflation were associated with sluggish growth and minor recessions.

Thirdly, not all prices do rise. It depends a lot on the type of good. Beer, mentioned above, has actually been increasing in price above the rate of inflation (partly due to higher tax) By contrast, the price of technological goods has been falling rapidly.

Generally, it is argued the optimal rate of inflation is about 2%. A small increase in inflation allows goods to find their optimal value.

Prices tend to rise because of economic growth. Increased economic growth usually causes a small amount of inflation.

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