The most common measure of inflation is the Consumer Price Index (CPI), which tracks the average change in prices paid by consumers for a fixed basket of goods and services over time.

The inflation rate (π) is calculated as the percentage change in the CPI:

$\pi_t = \frac{\text{CPI}_t - \text{CPI}_{t-1}}{\text{CPI}_{t-1}} \times 100$

Or using a base year:

$\pi_t = \frac{\text{CPI}_t - \text{CPI}_b}{\text{CPI}_b} \times 100$

Worked Example

Using data from Tanzania's National Bureau of Statistics (NBS):

• CPI 2018 (base year): 112.23%
• CPI 2019: 116.10%
• CPI 2020: 119.92%

Calculate inflation rate for 2019 (using previous year):

$\pi_{2019} = \frac{116.10 - 112.23}{112.23} \times 100 = \frac{3.87}{112.23} \times 100 = 3.4\%$

Calculate inflation rate for 2020 (using base year):

$\pi_{2020} = \frac{119.92 - 112.23}{112.23} \times 100 = \frac{7.69}{112.23} \times 100 = 6.9\%$

Therefore, Tanzania's inflation rate was 3.4% in 2019 and 6.9% in 2020.

Inflation can be classified according to how fast prices are rising:

• Creeping inflation: Prices rise by 5% or less per year. Often beneficial—encourages spending and economic growth.
• Walking inflation: Prices rise by more than 5% but less than 10% per year. Undesirable—overheats the economy.
• Rapid (running/trotting) inflation: Prices rise by 10–20% (sometimes up to 50%) per year. Harmful—money loses value quickly, discourages investment.
• Galloping inflation: Very high rate, above 50% per year. Disrupts normal economic activity.
• Hyperinflation: Prices increase by more than 100% per month—completely out of control. Governments may abandon their currency. Historical examples include Germany (1920s) and Zimbabwe (2000s).

Demand-Pull Inflation

Occurs when aggregate demand exceeds aggregate supply. Factors like increased consumer spending, investment, government expenditure, or exports raise demand, pushing prices upward.

In the textbook diagram, aggregate demand shifts rightward (AD₁ → AD₂), raising the price level from P₁ to P₂ while quantity supplied increases.

Cost-Push Inflation

Occurs when production costs rise significantly—such as higher wages, raw material prices, or oil costs. Firms reduce supply (aggregate supply shifts leftward) or raise prices to protect profit margins, leading to higher general prices and lower output.

Structural Inflation

A self-sustaining spiral where demand-pull and cost-push factors interact. Rising prices lead workers to demand higher wages; firms pass costs to consumers; prices rise again, triggering further wage demands—a continuous "wage-price spiral."

Monetary Inflation

Results from excessive money supply in the economy. When the money supply grows faster than output, more money chases the same goods, pushing prices up. This typically occurs at full employment where any demand increase is purely inflationary.

The main causes include:

• Excessive money printing: When the central bank (Bank of Tanzania) prints more money, more cash chases the same goods, raising prices.
• Rising production costs: Higher costs for raw materials, wages, or transport force producers to raise prices.
• Increased government spending: Without matching supply increases, higher government expenditure stimulates demand and pushes prices up.
• Importing high-priced goods: Inflation in trading partner countries or high exchange rates can raise import prices, feeding into domestic inflation.
• Tax policy changes: Higher indirect taxes (e.g., VAT) increase consumer prices.
• Excessive demand: When demand outstrips supply, shortages push prices upward.
• Natural calamities: Droughts, floods, or disasters reduce supply, raising prices.
• Political instability: Civil unrest disrupts production and supply, causing shortages and price increases.

Positive Effects (at low/moderate rates, below 5%)

• Promotes economic growth and investment: Expected rising prices encourage current spending and producer investment.
• Smooths labour market adjustment: Mild inflation allows real wage cuts without reducing nominal wages, facilitating employment flexibility.

Negative Effects (at higher rates)

• Discourages saving and investment: Uncertainty about future purchasing power reduces incentives to save or invest.
• Black market emergence: Sellers hoard goods anticipating higher prices.
• Adverse income distribution:
  • Fixed-income earners (wage earners, pensioners) lose purchasing power.
  • Variable-income earners (business owners) may benefit.
  • Lenders and savers lose as money's value declines.
  • Low-income earners struggle to afford basic needs.
  • Farmers suffer when agricultural prices rise slower than manufactured goods prices.
• Reduces production: High costs discourage output, reducing aggregate supply.
• Worsens balance of payments: Higher domestic prices make exports less competitive; imports become cheaper, causing deficits.
• Higher tax burdens: Inflation pushes taxpayers into higher brackets, increasing tax liability.

Contractionary Monetary Policy

The central bank controls money circulation to reduce inflation:

• Sell government securities: Bonds and treasury bills are sold to withdraw money from circulation.
• Raise bank rates: Higher interest rates discourage borrowing and encourage saving.
• Increase reserve requirements: Raising the cash reserve ratio limits banks' lending capacity.
• Selective credit control: Direct credit to productive sectors (e.g., agriculture, industry) that can increase supply.
• Quantitative credit restrictions: Limit the total loans banks can extend.

Contractionary Fiscal Policy

Government manipulates revenue and spending:

• Reduce government expenditure: Cuts public spending lowers aggregate demand.
• Increase direct taxes: Higher income taxes reduce disposable income and demand.
• Reduce indirect taxes: Lower VAT or import duties can lower prices.
• Borrow from the public: Government borrowing removes excess cash from circulation.

Other Measures

• Direct wage controls: Limit wage increases to break the wage-price spiral.
• Price controls: Establish price ceilings on essential goods (e.g., fuel, electricity in Tanzania).
• Production promotion: Provide subsidies and technical support to increase supply.
• External trade policy: Ban exports or encourage imports of essential goods in short supply.

In Tanzania, if you are a small business owner in Dar es Salaam selling maize flour and the price of a 1kg packet rises from TShs 1,000 to TShs 1,400 within a year, you are experiencing inflation directly. Understanding inflation helps you budget for higher costs of goods, anticipate price changes when buying stock, and make decisions—whether to absorb costs, adjust your prices, or find cheaper suppliers—to protect your livelihood and your family's purchasing power.