Why does inflation happen?

Example- I buy a loaf of bread to day for 1.25 and 70 years ago, it only cost .15. The machines to make the bread have gotten better, so the bread is made faster and cheaper. There are fewer people that bake, and more people overall, so you sell way more bread. If your costs go down and you’re selling in greater volume, why do your prices not go down instead, or at least stay the same?
Partly because the price of your ingredients has gone up. Okay, why is a bushel of wheat worth more now than 70 years ago? But of course it’s worth less because the dollar is now buys less…
I’m confused. I run a small business selling henna supplies and eventually this is going to affect me, too. I’ll have to raise my prices in order to have the same profit level as before.
I guess what i want to know is, who or what started inflation and can we stop it? Is there a benefit to it that I don’t see?

Well, generally inflation occurs when there is too much money for the amount of goods available to buy. This happens when the government prints too much money(like the hyperinflation of 1920s Germany), or the interest rates are too low for the economic situation, or other situations. Also, another cause of inflation is when the price of one good going up pushes the cost of many other goods up with it, like oil in the 1970s. (Even though over factors also contributed to the inflation of the 1920s, which I believe was the worst decade for inflation in the US, at least in the 20th centuary.

The thing is, mild inflation tends to simulate the economy; it tends to spark demand, as people figure I better use my money now or it won’t be worth as much later on. Thats why the Fed set interest rates lower during slumps like you see right now. Lower interest rates make it easier for banks to loan more money, which increases the amount of money in circulation. During economic booms, the rates go up to decrease the amount of money available, reducing inflation.

Finally, the opposite of inflation, deflation, is generally a bad thing. People tend to put purchases till later, figuring they can get more for the same amount of money. This reduces demands, and tends to cause the economy to stagnate. The Great Depression had deflation in the US; Japan’s current economic slump has been occupied by deflation for the last decade or so.
Most economist want a mild inflation for the greatest degree of economic stability and growth.

Also, when there is too much demand for too few goods. If I have the only 20 life jackets on a cruise ship they won’t sell for much, but if it starts sinking I’ll be able to get a pretty penny for each.

Those are two explanations. D.C. is offering a monetarist theory where MV=PY and V and Y are assumed fixed. If M, the amount of money out there, goes up, then prices go up.

What I highlighted is another theory, whose name I can’t recall off-hand. Maybe Keynesian. Anyway, it’s called Demand-Pull inflation. Then there’s Cost-Push, which is the cost of inputs going up, IIRC. A good example of Cost-Push inflation might be if the price of oil suddenly skyrockets. Since petroleum is such an important input for nearly every business, their costs go up=>prices go up.

Those are the three main theories that I know of.

I find it useful not to think of the price of bread going up, but as the value (buying power) or the Saudi Riyal (or whatever) going down.

A good point that a little inflation is a good thing. It makes it easier to pay off loans for example. In Japan they have a bad case of deflation, prices are going down.

A good thing you might think, but think again. The price of bread goes down, so why buy it today, I’ll wait until tomorrow. When evernone does that the economy is screwed.

Further the price of EVERYTHING goes down, inclunig the value of your house or any stocks you might hold, inclusing even the price of your hourly labor. Unless you have money in the bank you are in bad shape.

If you have a contract to pay money (like your mortage payments) you still have to pay $X a month, although you will have to work harder to earn it. Soon people give up on their mortages and banks are stuck with non-performing loans and houses that are worth little.

When you go to the bank you might find the cupboard bare.

So oddly a little inflation is a good thing.

That makes sense. Thanks, all.
If demand goes up more than supply, of course price will go up. That’s not inflation, that’s a buisiness opportunity. I’m talking about the slow, weaselly sort of inflation where stuff costs more for no visible reason.
I can see that deflation would be good in terms of paying off fixed-payment debts and is therefore bad. However, I don’t see why my money being worth less will help me pay off that loan, either.
I guess, other than being not-deflation, I don’t see the benefits of inflation.
Nobody feels the urge to buy stuff because it may cost more later. I mean, if I’m out of bread, I go out and buy another loaf. Must have bread, regardless of price. When my fridge breaks, that’s when I buy a new one. I don’t have a spare one because inflation will make it more expensive later.
On the other hand, some stuff is cheaper every year. This seems to be mostly computer stuff and some cars. Actually, cars go both ways. I think the computer thing is probably due to demand increasing, but in that case, price should increase…?
I’m trying to be a little stupid here to make sure I understand.

Even though I opened this thread because I thought it was about the inflation of the universe, I’ll contribute another very simple reason for inflation that is non-academic.

It has to do with annual salary increase expectations of employees. There is an entitlement mentality surrounding salary increases. Employees expect to get at least a 4 percent increase every year. I use the example of 4 percent because that’s been the average over the last 10 years or so in the companies I’ve worked for. Back in the late 1970s and early 1980s, the expectation was much greater than 4 percent.

Anyway, assuming every employee receives (on average) a 4 percent raise every year, the company is going to have to raise their prices 4 percent each year just to maintain their profit margin.

With Wall Street expecting that companies improve their profits over time, and increase the dividends they pay, companies are then forced to raise their prices more than the 4 percent each year.

The result? Inflation.

By the way HennaDancer, the price of computers keep dropping because of competition, not because of supply and demand.

The cost of producing the components of a personal computer continue to drop, allowing for companies to actually lower their prices and maintain their profit margins. Because people generally consider personal computers to be a commodity (ie-they’re equally good), the public will buy the one that costs the least.

So if one manufacturer lowers their price, the rest of the industry has to follow suit, or risk losing their existing revenue stream.

I was actually thinking of that. However, the 4% is generally given as a Cost Of Living Increase, apart from any extra salary for sticking around or doing a good job.

Your money is not “worth less” relative to the loan (unless the rate is tied to inflation). If you take out a loan for $10,000 and owe the bank $12,000 in two years time, you pay $12,000 even if that much money only buys half of what it did when you took out the loan. Let’s say you are in the business of selling widgets and the price over the two years doubles. Let’s also say that over the two years your costs of doing business also double. Whatever profit you were making before will still double assuming business stays the same (not necessarily a good assumption). So if you sold widgets for $100 that cost $50 to make and during those two years widget’s go up to $200 while your costs go to $100, your still doubling your profits. So if you do the same amount of business as you did before the inflation, that loan is alot easier to pay off.

If you’re talking about lower costs in microcomputers, I’m going to say that simple supply + demand isn’t the whole answer to the persistent drop in costs we’ve seen over the last 15 years.
I’d point the finger on that, and most decreases in technology costs to a combination of more efficient manufacturing technologies and higher volumes. Both of these factors lower the cost per unit to manufacture a good, which results in a lower equilibrium price at the wholesale and retail level.

Nope, that’s inflation. Trust us, I know at least me and js_africanus are actually economists (he’s a better one than I am, but I digress).

I think it might clarify things a bit if I go a little more in detail as to exactly what inflation is. Textbook definitions aside, it’s nothing more than the sum of price increases among all goods. Some goods, in fact, are decreasing in price; computers are the best example. They are decreasing in price in both nominal and real terms. $1,000 buys a LOT more computer than it did 20 years ago. Other goods are increasing in price, some more than others. Food and other agricultural products typically increase in price at minimal levels, while other goods such as prescription drugs increase at much faster levels.

Inflation is nothing more than basically averaging all of these increases up. The most common measure of inflation in the United States, the Consumer Price Index, is measured by sending people out to stores and writing down the price of stuff. This is done all over the nation, the prices are averaged and weighted and otherwise manipulated, and we conclude various things from the data. Typically the figure used is the CPI for all urban-consumers, but there are all kinds of other figures reported. For an overview of how all of this works, here’s a link to the guys that actually measure inflation in the United States:


So, the answer is, inflation is caused by lots and lots of different factors, each one essentially unique to the particular good you’re talking about. In general, I think that the more rapid inflation you see in goods like prescription drugs and lawyer’s fees is a result of “demand-pull” inflation, while the significantly slower sort is a result of “cost-push” inflation. Cost-push inflation, in the United States, is often a result of the increasing cost of labor (higher wages/salaries), which can indirectly cause increases in the cost of inputs even if your labor costs are fixed. For example, if cotton farmer Joe finds he has to pay his workers more money, that cost can get passed on to T-shirt manufacturers resulting in higher costs for a T-shirt, even if the manufacturers are paying the same wages for their laborers.

So why is the cost of labor increasing? Various reasons, one major one has already been discussed: people expect payraises. Another reason might be various state and federal labor regulations such as minimum wages, OSHA requirements, etc.

Ultimately, the current economic thinking is that with a given money supply, a healthy economy experiences at least some inflation, maybe between 2 and 6% annually. It’s as inevitable as death and taxes. General decreases in inflation are a trademark of economic stagnation, and so-called hyperinflation (Germany after WW1) can take place with poor monetary policy coupled with economic stagnation.

Well done desdinova. Comprehensive and intelligible.

Thank you thank you, my encore lecture will be entitled “Cross price elasiticity of demand between pornography and prostitutes.” I’ll be here all week folks!

“When push comes to shove, you gotta do what you love, even if it’s not a really good idea”

Hermes the burueacrat.

But that assumes that the company’s entire costs are attributable to wages and salaries. If salaries were 50% of costs, then prices would only have to go up 2% to cover raises. Furthermore, productivity gains and downsizing need to be factored into the equation.

Wage increases do not cause inflation.

I should have qualified my statement as “… all other things being equal, the company is going to have to raise their prices 4 percent just to maintain their profit margin.”

galen, would you be comfortable admitting that persistent wage increases contribute to inflation? From my point of view, anything that causes a company’s expenses to rise, increases the probability that they will need to increase revenue to compensate.

Are there other factors? Of course. I don’t believe I ever said there weren’t.

Oops. Even my modified statement is clearly incorrect. You are correct that if wages are 50 percent of expenses, the price increase would only have to be 2 percent.

Y’know, when I was a kid (stop groaning), it was always assumed that prices would go up from year to year. I can’t think of a single consumer item that went down. These days, the huge number of high-tech devices and internet-related services has produced an economy in which people expect the prices of things to go down. Sooner or later, I expect that the pace of innovation will slacken, it will all even out, and prices will go up for everything.

One factor that hasn’t been touched on too much in this generally excellent group of responses is that costs of production tend to fluctuate for a variety of reasons, and one contributes to the next.

If you’re a farmer, you might have a crop failure one out of five years. Not only does that wipe out your profits, but it means your buyers have to get their crops from other farmers. Result, the price of bread goes up.

When the price of bread goes up, workers demand higher wages so they can continue to buy bread. Result, the cost of labor goes up.

When the cost of labor goes up, manufacturers start to look for ways to increase productivity. Result, the cost of research and new equipment goes up.

Laid off workers then receive unemployment benefits. Result, the cost of government goes up.

At some point everything should stabilize, but at that point we’re only another crop failure, oil field closing, earthquake, etc. from another round.

There have been a lot of goods that have gone down in price significantly over the last 200 years due to industrialization. In the late 1800s: oil, steel, wheat, etc. Earlier still was cloth. More “recently”, radios got very cheap in the 1920s and a lot of makers went out of business. Same thing with TVs and the early 50s.

In short, once anything got mass produced, it’s price went down. You are not older than mass production.