What does inflation refer to in economic terms?

Inflation refers specifically to the rate at which prices for goods and services increase over a period of time. It is typically measured as an annual percentage change. When inflation occurs, each unit of currency buys fewer goods and services, indicating a decrease in purchasing power. This concept is crucial in economics because it affects consumer behavior, interest rates, and economic policy. For example, central banks like the Federal Reserve monitor inflation closely as it influences how they adjust monetary policy to ensure economic stability.

The other options do not accurately describe inflation. An increase in production capacity can contribute to greater supply but does not directly relate to the rise in prices. The amount of currency in circulation can affect inflation, but it is not a definition of inflation itself. Similarly, the difference between net income and expenses pertains to financial statements and profitability rather than inflation. Understanding inflation helps in making informed decisions regarding investments, savings, and spending in an economic environment.