why inflation happens. Why does it matter how much of our money is printed?
In: Economics
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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