Inflation - What is it?
So, what is inflation? what role does it play in our daily life. Did you ever wonder why a bottle of Coke that used to cost $1.20 now costs $2.25 or for that matter any other price. Usually products such as commodities offer the same functional value yet their economic value changes. For example, a bottle of coke still serves as a bottle of coke yet you have to pay a much higher price today. This is exactly what Inflation is all about. It's not the price of the underlying asset is increasing, it's because the buying power of your currency has gotten weaker and hence you must pay more of the weaker currency to buy exactly the same product.
Below example illustrates this concept a little better. I am using a cross currency example to illustrate it better.
Let's say an Australian Company charges AUD 100 for 1 gram of Gold. Also, in the foreign exchange market USD to AUD exchange rate is 1:1. Hence, for an American buyer, he needs to pay 100 US Dollars to buy the very same amount of 1 gram of gold.
Scenario 1: Let's imagine due to some government policies, USD has weakened against AUD and new exchange rate is: USD/AUD = 0.50 which means in 1 US Dollar now you get only 50 Australian Cents. This means US Dollar or anyone who is holding US Dollar in the pocket now has less buying power compared to when the exchange rate was 1:1. For the same American buyer to buy the very same 1 gram of gold, he now has to spend 200 USD. This is called Inflation where the buying power of the currency becomes weaker and everything priced in that currency must have a higher price when compared with old price.
Scenario 2: Let's imagine due to some government policies, USD has strengthened against AUD and new exchange rate is: USD/AUD = 2.0 which means in 1 US Dollar now you get you 2 Australian Dollars. This means US Dollar or anyone who is holding US Dollar in the pocket now can enjoy life with better life style. For the same American buyer to buy the very same 1 gram of gold, he now has to spend 50 USD only. This is scenario is Inflationary for Australians where the buying power of Australians now have weakened down against US Dollar.
Nitin
So, what is inflation? what role does it play in our daily life. Did you ever wonder why a bottle of Coke that used to cost $1.20 now costs $2.25 or for that matter any other price. Usually products such as commodities offer the same functional value yet their economic value changes. For example, a bottle of coke still serves as a bottle of coke yet you have to pay a much higher price today. This is exactly what Inflation is all about. It's not the price of the underlying asset is increasing, it's because the buying power of your currency has gotten weaker and hence you must pay more of the weaker currency to buy exactly the same product.
Below example illustrates this concept a little better. I am using a cross currency example to illustrate it better.
Let's say an Australian Company charges AUD 100 for 1 gram of Gold. Also, in the foreign exchange market USD to AUD exchange rate is 1:1. Hence, for an American buyer, he needs to pay 100 US Dollars to buy the very same amount of 1 gram of gold.
Scenario 1: Let's imagine due to some government policies, USD has weakened against AUD and new exchange rate is: USD/AUD = 0.50 which means in 1 US Dollar now you get only 50 Australian Cents. This means US Dollar or anyone who is holding US Dollar in the pocket now has less buying power compared to when the exchange rate was 1:1. For the same American buyer to buy the very same 1 gram of gold, he now has to spend 200 USD. This is called Inflation where the buying power of the currency becomes weaker and everything priced in that currency must have a higher price when compared with old price.
Scenario 2: Let's imagine due to some government policies, USD has strengthened against AUD and new exchange rate is: USD/AUD = 2.0 which means in 1 US Dollar now you get you 2 Australian Dollars. This means US Dollar or anyone who is holding US Dollar in the pocket now can enjoy life with better life style. For the same American buyer to buy the very same 1 gram of gold, he now has to spend 50 USD only. This is scenario is Inflationary for Australians where the buying power of Australians now have weakened down against US Dollar.
Nitin
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