Price Inflation’s Effect on Small Business, Plus 8 Tips to Adapt
by Anne Shaw
The Hartford Small Biz Ahead | Originally published July 27, 2022
What is price inflation? Inflation represents a decline in money’s value over time. When inflation rises, the value of your dollar goes down. With less valuable dollars, prices and wages increase. Ideally, they increase gradually and in step with each other. For instance, a soft drink that costs $2.50 now may cost $3 in the future. And a job that pays $16.50 per hour today may pay $20 later on.
Inflation has been a fact of life for quite some time. A reasonable rate of price inflation is expected, but when it rises too quickly, it can create challenges — especially for small businesses and consumers who see a sudden drop in their purchasing power. Sometimes, as costs start to rise, there’s a rush to buy goods and materials prior to bigger price hikes. This in turn drives up demand, and higher demand can further increase costs. When inflation rises too quickly, wages can’t keep up. As a result, consumers often prioritize necessary purchases, reducing their spend in other areas. Depending on the type of product or service small businesses offer, this can reduce their customer base.
Whether price inflation occurs at an expected rate or suddenly, what causes money to lose value? The root cause of inflation comes from a larger supply of money, whether through increased credit in the banking system, governments printing more money or legal devaluing of currency. These cause three types of inflation, each with its own contributing factors:
- Built-in inflation is based on the expectation that inflation is inevitable. People expect prices and wages to rise over time, so they do, which creates a price-wage cycle. The cost of living goes up due to inflation, so wages follow suit. As the economy reacts to higher wages, products and surveys once again rise in price, and so on.
- Demand-pull inflation occurs when demand is too strong for available supply. When production capacity can’t keep up, prices rise in response. Typically this happens when an increase in the supply of money and credit boosts consumer spending.
- Cost-push inflation happens when production costs drive up the prices of finished products. This can occur when prices rise for energy or a specific commodity often used in production processes, like lumber or metal. Eventually, the higher production costs make their way to the end-users who pay a higher price to purchase.
Steeply rising house prices throughout the early 2020s can be attributed to both demand-pull inflation and cost-push inflation. Demand for homes shot up as many people facing stay-at-home orders decided to leave urban areas and purchase homes with more space elsewhere. Consumer demand outweighed the current supply of homes, leading to demand-pull inflation. At the same time, the cost to build new homes rose due to pandemic-related shortages and supply chain backlogs that drove up the cost of building materials and led to cost-push inflation…(CONTINUED)
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