why inflation happens. Why does it matter how much of our money is printed?
In: Economics
Let’s forget about money for a minute. There’s a whole bunch of goods being produced every single day. Potatoes, computers, 2×4’s, pants, and so on. Each of these goods takes time and energy to produce. Often, also, expertise and equipment. So, instead of having everyone do everything, I can make cars and you can make wheat. Then, I give you a car for an amount of wheat that’s fair (based on how much time and energy each one took to produce).
Now we have an issue. I have a bunch of wheat, and I can’t eat raw wheat. Plus, I also need water, gas, electricity…
So, what? I trade some of that wheat for each of those things? Then I’ll be hopping around all day trying to find someone to make the right trade with.
Instead, we have money. I sell a car for money, and that money can then be traded for anything I want. Money never expires, and is not consumed, so it makes a very good ‘token’ for the time and energy spent on creating something.
So, now, this means that the amount of money spent in a day/week/year/whatever must (roughly) represent the amount of time/energy that is put into doing work by the entirety of humanity. However much money is spent overall must equal the overall labor/production.
So, since labor/production don’t normally change suddenly from year to year (COVID notwithstanding), an increase in the money floating around results in less value per individual dollar.
Ex: There are a million dollars being spent every day, paying for ten thousand man-hours of labor. That’s $100/man hr. Suddenly, that doubles to two million dollars being spent every day, but people are still only working ten thousand man-hours. Now, it’s $200/man hr. It takes twice as much money to pay for the same amount of work!
Money gains its value from the country’s economy. The better a country’s economy is, the more valuable the money is. If you increase the amount of money in circulation without equally increasing the value of the economy, the money become less valuable—inflation.
Let’s say the economy is valued at $1 billion, and there is also $1 billion available in money. This means that a single dollar is valued at one billionth of the economy. If the country decides to print ten times as much money, but the economy doesn’t change, then that means that money will be worth ten times as less than before. Instead of one dollar represent one billionth of the economy, it now takes ten dollars to get the same value.
Money is used as a placeholder for value, so if you want to obtain something of value you need money in order to exchange for it. People place value on money because it is somewhat rare; you cannot obtain it without some effort so people are willing to exchange things of value for it.
Generally speaking the more money there is around in circulation the easier money is to obtain. If money is easier to obtain the amount of value each individual unit can represent decreases. If everyone has tons of cash you won’t be willing to give up something you value greatly without them giving you a whole lot of cash in return. If people only have a little cash then you might be willing to accept less for the thing you value greatly, as that small amount of cash will in turn allow you to trade for things of significant value.
Contrary to popular believe inflation has almost nothing to do with printing money(except of course hiperinflation) and everithing to with demand and offer of goods
TL;DR Everything falls back on Supply and Demand. If your Supply of Money is higher than your demand of it and your demand of a good/service is higher than your supply of that good/service, you are willing to spend more money for that good/service.
Aight, so inflation is a measure of the rising costs of goods and services in an economy right. Two things affect inflation the most: productuon cost and supply/demand ratio. As the production cost of a good or service rises, generally namely in labor wages or cost of raw materials, companies will attempt to charge more for a good or service they provide in order to lessen the amount of profit loss they suffer on investment in those production costs. Normally this wont do much on it’s own, but when the demand for a good or service is higher than the supply or availability of it, then the amount people are willing to pay for it will increase at a similar rate. Keep this in mind as I continue.
Now what does that have to do with simply printing more money and dumping it i to the economy? Simple. If you print more money, the amount of goods doesn’t change. However, if you print money, households will have more cash and more money to spend on goods. If there is more money chasing the same amount of goods, firms will just put up prices.
Example:
Suppose the economy produces 1,000 units of output of a given good, and that the money supply (number of notes and coins) = $10,000. This means that the average price of the output produced will be $10 (10,000/1000)
Suppose then that the government prints an extra $5,000 notes creating a total money supply of $15,000; but, the output of the economy stays at 1,000 units. Effectively, people have more cash, but, the number of goods is the same. Because people have more cash, they are willing to spend more to buy the goods in the economy. The price of the 1,000 units will increase to $15 (15,000/1000). The price has increased, but, the quantity of output stays the same. People are not better off, and the value of money has decreased; e.g. A $10 note buys fewer goods than previously.
Therefore, if the money supply is increased, but, the output stays the same, everything will just become more expensive. The increase in national income will be purely nominal.
This can also devalue a country’s currency against another country’s currency if it did not also experience similar inflation. With Country A’s currency buying fewer goods, more currency is needed to buy the same quantity in Country B’s goods.
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