In laymans terms, please explain the process of inflation?

In laymans terms, please explain the process of inflation. Asked by The_Baron 55 months ago Similar Questions: laymans terms explain process inflation Recent Questions About: laymans terms explain process inflation Business > Financial Planning.

Similar Questions: laymans terms explain process inflation Recent Questions About: laymans terms explain process inflation.

Bernanke's headache You've actually asked one of the most complicated and important questions of economics. So the explanation here is going to be a little long and tedious, but it doesn't require a PhD, at least as far as I'm going to go in it. The basics of inflation are easy to understand.

When there's more money in the system, prices go up. That's the most fundamental rule in economics: prices are set by the law of supply and demand. The higher the supply, the lower the price.

The higher the demand, the higher the price. You get two curves, and where the curves meet, that's the price. Inflation comes whenever there's increased demand.

A lot of things can cause increased demand. The simplest is when the government decides to print more money and give it away. Everybody has more money, so they want to buy stuff to spend it on.

You don't actually get more stuff, because prices just rise to match, since you haven't changed the supply. That's why we don't get out of the national debt by just printing more money. (But some countries try it anyway, and get 1,000% inflation when they do.

) Even without that, prices gradually rise over time, essentially because people expect it to. Older employees demand raises. That means they have more money, increasing demand.

That's supposed to be balanced by even older workers retiring, but people are living longer. That's what's causing inflation in health care. Companies produce new drugs, and people want them: that's more demand.

People live longer, so they need more medication: more demand, more inflation. Inflation tends to spiral out from a source like that. More money for drugs means more money for health-care workers (or at least, for their executives), so they spend more on everything else (food, clothing, housing), raising prices there, too.

That inflation tends to fuel itself. For example, we expect prices to rise so we raise the minimum wage every so often. That means more money for minimum wage workers, and so they spend more money, and so prices rise.

Self-fulfilling prophecy. So no matter what, prices do gradually rise over time, if for no other reason than because we expect them to. The government does pump money into the system in a variety of ways, because that money can be invested and bring bigger returns.

The most obvious way they do that is by loaning out money. Loans aren't the same as giving it away, but if the rate of interest is too low, people will take the loan, invest it in something, and return the rest. The return is profit, and the investment is good because it gives American more actual stuff.

But you can only acquire that stuff so fast; there are only so many new ideas. Set the interest rate too low, and people just spend rather than invest, increasing demand and causing inflation. That's bad, not because the price is too high (after all, there's more money in the system, so on the whole it balances out) but because that's not distributed evenly: some people get rich but others get poor.

It makes it hard to plan things, and that kind of inflation makes people scared and they tend to spend their money (since it'll be worth less tomorrow) rather than save it. So a little inflation is good and necessary, and keeping a handle on it is the job of the Federal Reserve. (They loan out the government's money, and they also set the rules for how much banks can loan out).

But the interactions are complicated, and many PhDs go into trying to unravel it.

Actually, the basic concept isn't complicated at all. At any given time, the economy produces and has ready for sale a certain amount of goods and services, which I’ll call X. At the same time, there is an amount of money available to purchase those goods and services that we just discussed.

Let’s call that amount of money Y. If over time, X increases at the same speed as Y, prices are stable. If over time, Y increases faster than X, you have inflation.

If over time, X increases faster than Y, you have deflation. Where it gets tricky is in defining and measuring X and Y. Forecasting future Xs and Ys can get even more complicated.

But the concept itself is real simple. If the quantity of money increases more rapidly than the quantity of goods and services available, you’ve got yourself INFLATION. Sources: Many Econ courses and a lot of reading Snow_Leopard's Recommendations The Economics Of Inflation - A Study Of Currency Depreciation In Post War Germany Amazon List Price: $31.95 Used from: $37.25 Average Customer Rating: 4.0 out of 5 (based on 1 reviews) The Conquest of American Inflation.

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I can try to explain it, but I sure can't fix it. Wikipedia defines inflation as "in increase in the money supply," but the definition begs the question. I think what most people mean by inflation is a period of rising prices.

This does happen because of an increase in the money supply, but how? What increases the money supply that fuels the inflation that comes home to roost in the house that Jack built? People work in return for a salary.

In some calculator-in-the-Twilight-Zone way, your salary is linked to the market value of whatever it is you produce. Let’s say you’re a gizmo-maker; you produce a certain number and quality of gizmos, and you’re paid accordingly. You take your gizmo money and go out and buy cars, sofa-beds, memberships in health clubs and the occasional primo bottle of wine.

Life is good. One day you figure out how to produce twice as many gizmos in the same amount of time with no loss of quality. You get paid more, because you produce more.

You get paid more, so you can spend more. You got out and buy a second car, a sail boat, all the great MGM musicals on DVD and you build a wine cellar and start stocking it. If everyone in your company can crank out more gizmos, you’re all gonna be out there shopping and spending.

(Even saving feeds the cycle; banks take your savings and loan them out to somebody else to spend). More shoppers means a need for more things (include intangibles here) to buy. Factories and artisans, software designers and wine stewards all get busier, so they end up with more money and join the lines at the check-out counter.

In a "hot," i.e. Rapidly growing economy, pretty soon employers will be elbowing each other out of the way to compete for more workers to turn out more stuff, and one of the most enticing incentives to "come work for me" is paying higher wages. You do it, the Acme Gizmo company in the next county does it, Urban Gizmo in New York and Dude Gizmo in California do it, and now you’ve begun to pump even more money into people’s pockets, where it is unlikely to find its eternal resting place.

Of course the human resource people in all the gizmo companies will have to deal out a round of pay raises just to keep you and the other experienced gizmo makers happy, so you get to share in the benefits of a scarce resource (your skill) as well. Next thing you know, the owner of Gizmos-R-Us notices that the things are just flying off the shelves, and by September he’s running a 20-page waitlist for Christmas Gizmos. And this is in spite of the fact that gizmo makers everywhere have raised the wholesale price because each gizmo-maker is getting a higher wage, and so he’s already had to push the retail prices up to protect his margins.

What does he do? Of course--being a savvy businessman, he raises the price even more! And hires more salespeople to handle the customers!

It’s a merry cycle, and of course not anywhere near as simple as this example. Factor in this: when you first revolutionized gizmo production, the cost of making each gizmo went down because the labor-per-gizmo was cheaper. So the first thing improved productivity does is lower, not raise, costs and prices.

And there’s the possibility that the world doesn’t need twice as many gizmos, so you may find yourself suddenly in a part time job. You have less to spend, so you reduce the amount of money you’re putting as much money into the economy. But do you really?

Maybe for a while, but eventually you’ll get a second job or your wife will go to work to fill the gap. And if the price of gizmos goes down, people may buy just as many gizmos but they’ll also start buying gadgets as well, starting an inflationary trend in another industry. So why doesn’t inflation become an unstoppable force and end up choking us in piles and piles of money?

In the short run or on an individual basis it may do just that, but over the long run we, being clever human animals, keep thinking up new inventions IPod XXI, or fun new things to do with old inventions corner the market on old Texaco road maps and open a private museum, or marvelously amusing sink holes in which to plow our money fly first class; wear designer jeans; add a second, heated swimming pool. That gives us chances to keep everybody working without flooding the market. And so far, there are still markets who haven’t joined us on the merry-go-round.

We can "create" new markets (i.e. , let more people get into the game) by raising their productivity outsourcing. Not to worry, though; before you know it we’ll be getting our investment back by opening a US-owned or franchised Starbuck’s on every streetcorner in China.

That’ll teach ’em. Roseredcity's Recommendations White Trash with Money Amazon List Price: $18.98 Used from: $8.981 Average Customer Rating: 4.5 out of 5 (based on 368 reviews) We're Only in It for the Money Amazon List Price: $18.982 Used from: $8.980 Average Customer Rating: 4.5 out of 5 (based on 87 reviews) Where's the Money? Amazon List Price: $8.981 Used from: $8.982 Average Customer Rating: 5.0 out of 5 (based on 14 reviews) Money for All Amazon List Price: $8.980 Used from: $8.980 Average Customer Rating: 4.0 out of 5 (based on 4 reviews) Mo' Money: Original Motion Picture Soundtrack Amazon List Price: $8.980 Used from: $0.15 Average Customer Rating: 4.0 out of 5 (based on 4 reviews) In It for the Money Amazon List Price: $8.980 Used from: $0.98 Average Customer Rating: 4.5 out of 5 (based on 40 reviews) Money Mammals Amazon List Price: $18.981 Used from: $18.982 Average Customer Rating: 5.0 out of 5 (based on 4 reviews) Seems to be a crossover concern.

Let's do a thought experiment.... Let's do a thought experiment: In Anytown USA, an armored truck drives down the streets with it's back door iopen and millions of dolalrs in cash go flying out. The residents are not particularly honest and they pick up the money and keep it. After a few weeks, they call decide things have cooled down enough and they all take their $100,000 in cash down to the local car dealer.

Now the car dealer has ten cars, list price $20,000, and FIVE HUNDRED customers waving cash at him. What will he do? He will probably sell the first car to the highest bidder.

Let's say that's you and you bid $40,000 for that $20,000 car. The town has just experienced a 100% jump in the cost of cars. That's inflation, when there's more money chasing fewer goods.

You Buy the Same Thing but it Seems to Cost More Here are some analogies: if a cup of coffee were to cost $1 in an inflationary economy, the same cup may cost $1.25 tomorrow. This is the result of an expanding economy; the economic "pie" is bigger now than it was. If the economy in the 1950's were the size of a personal pan pizza, today it's a large pie with all the toppings.

If you used to be able to buy a house with a slice of personal pan pizza, today you need a slice of the large pie. It's still 1 slice, but it's physically a larger slice. The economy has expanded and so has the pizza.

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