Inflation affects the economy in big ways by changing how much people buy and how much businesses can produce. Let's break this down into two parts: Aggregate Demand and Aggregate Supply.
How Inflation Affects Aggregate Demand:
Purchasing Power: When prices go up, people can't buy as much with their money. For example, if something cost 100 SEK last year and inflation is 5%, that same item will cost 105 SEK this year. This makes people think twice before buying it.
Interest Rates: To fight high inflation, banks often raise interest rates. This means it's more expensive to borrow money. When borrowing is down, businesses may spend less on investments. This can lower the overall demand for products.
How Inflation Affects Aggregate Supply:
Production Costs: Inflation raises the costs for businesses trying to make their products. For instance, if the prices of raw materials go up, companies might produce less. This can make the supply curve shift to the left, meaning less is available for sale.
Wage-Price Spiral: As prices rise, workers start asking for higher wages to keep up. This increases costs for businesses. To cover these higher costs, businesses may charge even more for their products, which keeps inflation going.
In short, inflation tends to lower demand because people have less money to spend and there are higher interest rates. At the same time, it creates problems for supply because of increased production costs. It's important to find a balance to keep the economy stable.
Inflation affects the economy in big ways by changing how much people buy and how much businesses can produce. Let's break this down into two parts: Aggregate Demand and Aggregate Supply.
How Inflation Affects Aggregate Demand:
Purchasing Power: When prices go up, people can't buy as much with their money. For example, if something cost 100 SEK last year and inflation is 5%, that same item will cost 105 SEK this year. This makes people think twice before buying it.
Interest Rates: To fight high inflation, banks often raise interest rates. This means it's more expensive to borrow money. When borrowing is down, businesses may spend less on investments. This can lower the overall demand for products.
How Inflation Affects Aggregate Supply:
Production Costs: Inflation raises the costs for businesses trying to make their products. For instance, if the prices of raw materials go up, companies might produce less. This can make the supply curve shift to the left, meaning less is available for sale.
Wage-Price Spiral: As prices rise, workers start asking for higher wages to keep up. This increases costs for businesses. To cover these higher costs, businesses may charge even more for their products, which keeps inflation going.
In short, inflation tends to lower demand because people have less money to spend and there are higher interest rates. At the same time, it creates problems for supply because of increased production costs. It's important to find a balance to keep the economy stable.