Certified Financial Management Specialist Practice Exam

What does inflation refer to in economic terms?

1. Rate at which prices decrease over time

2. Rate at which prices increase over time

3. Rate of interest on bank loans

4. Rate of return on investments

The correct answer is: Rate at which prices increase over time

Inflation is defined as the rate at which the general level of prices for goods and services rises, resulting in a decrease in purchasing power. When inflation occurs, each unit of currency buys fewer goods and services, which indicates a decrease in the value of money. It is a crucial economic indicator that reflects the health of an economy, as moderate inflation is typically associated with economic growth, while high inflation can lead to uncertainty and reduced consumer spending. The other options do not capture the concept of inflation. For instance, a decrease in prices over time relates to deflation, which is the opposite of inflation. The rate of interest on bank loans pertains to borrowing costs and is influenced by various factors including central bank policies, but it does not define inflation. Similarly, the rate of return on investments refers to the profitability of an investment and is not directly related to the changes in the price level in an economy. Therefore, the correct understanding of inflation solely aligns with the increasing prices over time.