Inflation refers to a sustained increase in the general price level of goods and services, which erodes the purchasing power of money over time. The most familiar price index is the Consumer Price Index (CPI), which tracks the average change in prices paid by urban consumers for a fixed basket of goods and services. CPI differs from the GDP deflator in important ways: while CPI measures only consumer goods and uses a fixed basket that must be updated periodically, the GDP deflator covers all domestically produced goods and services and automatically updates its basket each year to reflect current production patterns.
Economists distinguish several causes and forms of inflation. Demand-pull inflation arises when aggregate demand outpaces aggregate supply, pulling prices upward in what is often described as "too much money chasing too few goods." Cost-push inflation, by contrast, originates on the supply side when rising input costs such as wages or raw materials force producers to raise prices even without excess demand. Hyperinflation describes extremely rapid price increases, typically exceeding 50% per month, which can collapse the real value of currency and destabilize the economy. Deflation, the opposite phenomenon, is a sustained decline in the general price level that can become self-reinforcing as consumers delay purchases in anticipation of lower prices. The unusual combination of stagnant growth, high unemployment, and high inflation is known as stagflation and presents policymakers with a particularly difficult challenge because standard remedies for unemployment tend to worsen inflation and vice versa.
The unemployment rate is calculated as the number of unemployed workers divided by the labor force, multiplied by 100, and counts only those actively seeking work. Economists classify unemployment into three main categories: frictional unemployment, which is short-term and arises naturally as workers search for jobs or transition between careers; structural unemployment, which stems from a mismatch between workers' skills and the requirements of available jobs, often triggered by technological change or industry shifts; and cyclical unemployment, which rises and falls with the business cycle. The natural rate of unemployment includes only frictional and structural unemployment, representing the rate that prevails when the economy operates at full employment.
Two important empirical relationships connect unemployment and output to inflation. Okun's Law observes that for every 1% rise in unemployment above the natural rate, real GDP tends to fall roughly 2% below potential output, providing a rough guide to how labor market slack translates into production losses. The Phillips Curve illustrates a short-run inverse relationship between inflation and unemployment, suggesting that policymakers may face a trade-off between the two, though this relationship weakens in the long run when inflation expectations adjust.