Why aren't the prices going down when inflation is so low?

Inflation - been a buzz word for quite some time now. If you have a habit of reading at least the newspaper headlines on a near-daily basis, you wouldn't have missed the inflation numbers. Well, I would say most of us are still ignorant about how inflation affects us directly or indirectly. What we do know is, when the inflation numbers makes it to the front page of most of the newspapers, it should be something serious. Inflation breaching 12% or touching zero, financial analysts always have list of problems associated with it. There is no ideal inflation number. Its just a relative indicator of how far or near we are from trouble.

One major misconception most of us have is inflation and prices are directly related. Let me try to explain it with an example. Say, the price of an item is Rs. 100 at same time last year and its Rs. 110 now - so the inflation is at 10%, which simply means the item is 10% expensive. So inflation is just an indicator of rate of price movement not the real prices. So when the inflation is at 0.44%, as is the case now, the Rs. 100 item last year is now at Rs. 100.44.

What happens when inflation nears zero - which means prices aren't increasing at all - that get us into deflation state or negative inflation.

Some smart readers would have already calculated that when the inflation starts moving negative the prices starts going down.

Now, is that a phenomenon to be happy about? The answer is no. You might be wondering how can we not feel happy about the prices going down. To understand that lets understand how the prices actually go down.

The main reason for prices to go down is demand-supply mismatch, i.e, either production is more than consumer demand or demand going down, may be due to recession. In both the cases, companies may have to sell their goods cheaper. As a consequence of this, companies start incurring loses. The end result of all this - companies trying cut cost. The easiest way of doing that - job cuts or layoffs.

Hope this helps improving your understanding of inflation/deflation. I have tried to keep it simple avoiding major financial terms.