Could someone please explain inflation to me. I know what inflation is, but why? Why must things get more expensive? And if wages are being increased in a(at least a small amount) relative proportion…then what’s the point? What is the fundamental reason for inflation?
After watching a show about the 50’s where they talked about cost of living and such compared to today…it really makes me wonder why inflation exists.
In essence, it’s a matter of demand and greed. Three people are willing to buy my widgets at my initial price. I discover that I only have two widgets, and if I raise my price, two of the three are still willing to buy my widgets. Thus, I raise my price since I want more money.
Of course, I’m sure that there will be folks who get all prissy and sissy about calling this “greed”, but it is. It may just be a little greed, but it’s still greed.
Let’s not oversimplify. Inflation is a technical indicator of economic behavior, and as they say: ask a dozen economists for an opinion and you’ll get thirteen answers.
Though the source is an odd one, this Causes of Inflation page has a good overview of the technical theory, with charts yet.
“Cost Push” is a way to “push” the greed factor another level back in the stream.
By that logic, then, deflation happens when people get less greedy!
Not likely. Better to leave the emotions out of economic explanations.
I’ll try:
Money is a commodity; like wheat or cabbage. You can’t tell where you wheat came from, or at least, you don’t bother. When there’s too much wheat, the price falls. And visa-versa.
Money is manufactured by the government out of worthless paper. If too much is made, the value drops (in relation to, say, wheat). If not enough is made, the value rises. It’s easy to make more and people prefer a slightly infationary economy. I can pay my mortgauge with cheaper money than before, among other things.
People really hate recessions and will vote out politicians who are responsable for one. Likewise hyper-inflation. But politicians who bring us a gentle inflation live long and happy lives.
Here’s a though experiment: A country is experiencing prosperity. Over a year, everything doubles. Twice as many people, houses, jobs, etc. You have to have twice as much money too; to keep the balance.
Oh, no! Not the “printing too much money” theory of inflation!
The money supply is unaffected by activities at the Bureau of Engraving, unless the warehouse workers are leaving palettes of 20s out on the sidewalk after work. 
The amount of money printed is a response to, rather than a cause of, increased desire for liquidity by the public.
The primary reason for increases in the money supply are loans.
jsleek, you’re right that there is a commodity at stake here. I’d say that that commodity is immediate purchasing power. I want that new car today, damnit, and I pay the premium for that desire in future interest to satisfy it. Of course when I buy my new car the dealership immediately deposits the money from my purchase in their own bank, and that bank lends that money out, which gets deposited and lent out, ad (nearly) infinitum. This is the basis of fractional reserve banking. (For fun Google on fractional reserve banking and see how many conspiracy sites pop up.) With easy loans available demand in the economy rises without any attendant rise in production. Thus, easy credit is a driving source of inflation. This attitudes makes me something of a monetarist, but I recognize this influence as only one of a number of drivers. (Quick question for eco-geeks: Can you tell which years I took Econ in college?)
The average person should prefer a moderately inflationary economy. I borrow capital from the rich folks and get to pay it all back with devalued bucks, as you said. I accrue real worth and the guy with the opera hat and cane receives a lesser rate of return. Just make sure that real return exceeds the inflation rate or nasty things tend to happen. (See: late '70s, in your texts.)
We have here not only a problem in economics, but in semantics.
Inflation used to mean an increase in the money supply disproportionate to the growth of goods and services. The result of this circumstance is rising prices. Under this definition and ones like it, inflation is a cause of rising prices, although not the only one.
Then journalists and a lot of other people who should have been more careful with their language started to use the word “inflation” as a synonym for increasing prices, even though there are other circumstances besides inflation of the money supply which can cause price of one thing or another to increase. These other causes include price fixing by suppliers and increased demand because of new uses for a commodity, and increased demand because of speculative investment, and increased demand simply because of a rumor, or a fad.
Back in the 70s newspapers and magazines started saying things like “Rising Prices Fuel Inflation”, which is sort of like saying “accidental fires lead to spilled gasoline”. Or at least it was like saying that. At first a lot of people complained about this kind of sloppy language but in time the concept of rising prices and inflation became so conflated that the term “inflation”, in common use, and even in many discussions by economists, has effectively no clear, distinct meaning any more.
This has resulted in making inflation of the money supply harder to discuss sensibly and to deal with. This is particularly unfortunate as economics tends to deal with abstractions which are hard to picture precisely anyway.
Take, for instance, the whole idea of “the money supply”. Currency is not the same thing as money. Money is an abstraction (although a very real one), and “the money supply” is an intangible which is represented in part by currency but far more by entries in bank ledgers; as noted above, the level of borrowing is the single most significant factor in determining the size of the money supply.
Why is money worth anything? Because it can be used to buy things.
Suppose there were an economy on an island somewhere in which there were just two things to trade in, say, pineapples and clams. Suppose further that the supply of these was about equal, and people valued the two things about equally. It is easy to picture that one pineapple would be worth about one clam, and vice-versa. Suppose further that one day clams suddenly become far more common, so that the island is postively inundated with them.
Everybody now has a lot more clams. So: is everybody rich? Not if everything else on the island remains the same; a person can only eat so many clams, and there isn’t anything else that can be done with them except trade them for pineapples. It is fairly easy to picture that the individual clam is now worth less than before, and the individual pineapple (as measured in clams) is more valuable.
For “clams” substitute “money” and for “pineapples” substitute “goods and services”.
When the supply of money is increasing faster than the supply of things that can be bought with it, indivdual units of money lose some of their value relative to the stuff they can buy; the increase in the supply of money does not represent an increase in real substance or value; it is just so much hot air; it’s just so much…“inflation”.