Mainstream price inflation

I'm sure most here know the standard price inflation theories. Employment opportunities increase price inflation, governments paying their debts, production disruptions, etc etc. But the thing I can't get my head around is that if we assume a completely static money supply, then how could one price rise, without others falling? So am I right in assuming that overall price inflation cannot occur without actual inflation occurring first? Or am I neglecting something?

Couldn't there be price inflation if the supply of goods fell?

Yeah, I think you're correct. That is what distinguishes mere price increases from inflation (which causes all around price increases.)

-Jon

Ivan Ivanov:

Couldn't there be price inflation if the supply of goods fell?

Not overall, if I have understood this correctly. If you have an unchanging supply of money and the price of one product goes up due to a decrease in supply, that increase has to come from somewhere. So if the price increase doesn't come from inflation, it has to come from the price of other products.

This is of course horribly simplified and doesn't take into consideration stuff like demand changes, etc. But I think it's a basic supply and demand problem that mainstream theories don't seem to consider very thoroughly.

Libertas est Veritas:

This is of course horribly simplified and doesn't take into consideration stuff like demand changes, etc. But I think it's a basic supply and demand problem that mainstream theories don't seem to consider very thoroughly.

No, I mean other things being equal.

If there's a sudden shortage of tomatoes, theyor price will go up, but why should other prices go down?

Now, if there's a shortage of all goods, say as a result of a natural disaster, or war, why wouldn't all prices go up, if the amount of money stays the same?

 

Libertas est Veritas:

But the thing I can't get my head around is that if we assume a completely static money supply, then how could one price rise, without others falling? So am I right in assuming that overall price inflation cannot occur without actual inflation occurring first? Or am I neglecting something?

You're correct.  If the supply of money was constant, assuming supply and demand also remain constant, you would see prices of other goods and services drop.

The only way to have aggregate price increases, is if the money supply expands.

Deflation then, would be when the money supply stays constant or contracts.  Delfation under a constant money supply is brought about by efficiency and more products coming to market (higher standard of living).

 

 

Ivan Ivanov:

If there's a sudden shortage of tomatoes, theyor price will go up, but why should other prices go down?

Let's assume two things: the money supply is stable at X and the supply and demand of all goods remains the same. Now, if in that scenario the price of one product increases by Y and there are no price decreases in the other products, then the end money supply would have to be X+Y. So it's not possible to have overall price inflation without expanding the money supply.

Ivan Ivanov:

Now, if there's a shortage of all goods, say as a result of a natural disaster, or war, why wouldn't all prices go up, if the amount of money stays the same?

Where would the extra money come from? My mind is a bit slow today, so my reasoning might not be up to par. But if the supply of all goods fell uniformly, then wouldn't the price of essential goods (food, shelter, etc) increase while the price of less essential goods (cars, fur coats) drops?

Anyway, I have no idea if this makes sense. I was just reading the mainstream theories and it I can't seem to find how they address this issue. Anyone know?

Given that all other things are equal, so is your income, and you will thus increase the amount spent on that particular good, thus diminishing your purchasing power, thus diminishing the amount of other goods you will purchase, thus causing a drop in their prices.

-Jon

Ivan Ivanov:

If there's a sudden shortage of tomatoes, theyor price will go up, but why should other prices go down?

If I've got enough money to buy tommatoes and milk, and the price of either one goes up, now I have to choose which I'm going to buy because I can't get both.  If the price of tomatoes goes up it will result in people buying less of something else, which will result in a price decrease in that good.

That's why most economists accept that you can't have price inflation without credit expansion. That's also why Keynesians advocate high taxes and big surpluses during economic booms - as a way to remove some of the money circulating from the economy. The problem with that strategy is that they almost never remove the necessary amount of money to actually prevent inflation from happening.

With a strongly conserved money supply (e.g. gold or a divine fiat money that never increases in supply), prices denominated in money will increase whenever the demand for money goes down. When the demand for money goes down, fewer goods and services must be offered in exchange for money - or, higher prices for the same goods and services. Normally, however, the demand for money goes up, not down.

What determines the demand for money? Population plays a role - as there are more actors demanding the use of the money, the price of money increases and the prices of everything measured in money decreases. This is why we expect a gradual fall in prices given a rising population. Uncertainty also plays a role. When times are uncertain, the demand for longer-term stores of money for greater deferral of consumption increases and the amount of short-term spending on immediate consumption drops. This is not a reflection of some mysterious "deficiency of demand" as the water-headed Keynesians make out, but a reflection of an increase in the demand for money itself. When people restrict their spending on all goods and services, the prices of goods and services, generally, will tend to go down.

I think that division of labor and consumer choice must also play roles in the demand for money. As the division of labor increases, the price of labor goes down, since there are more ways to buy the same good or service. Similarly, as consumer choice increases, prices must go down since there are more options of how to spend any given amount of money. Those choices are all bidding against one another in competition for the consumer's money. They must continually offer more goods and services in exchange for the consumer's money.

I am irked every time I hear on a documentary or radio program that "an ounce of gold bought such-and-such 2000 years ago and it still buys the comparable such-and-such today." If that is true, then economic progress is an illusion. If the real prices of comparable quality goods and services are not falling, then we are making no headway at all. The reality is that things are constantly falling in price. I paid the equivalent of two gold coins for my pickup truck. It can travel more than 80mph, has A/C and a (really crappy) stereo. It can go into 4WD on backroads and operates for hours and hours on end without fatigue. It is comparatively inexpensive to fuel. 2000 years ago, I could not even have gotten a mode of transportation of this quality. But the best quality transportation I could have gotten (horse and saddle), would have cost far more than two gold coins and a lot more to fuel.

It is frightening just how abysmal our economic literacy must be that people consider it normal that prices are always increasing. Somehow, it is expected that it should always be getting more expensive to get by and harder to make a living. People associate population increase with a rise in prices, when elementary logic tells us to expect the exact opposite. As more people demand the use of money, prices in terms of money should go down. As the division of labor and consumer choice increase, we should also expect prices to go down. And while uncertainty can cause temporary decreases in prices as people defer consumption more than usual, price decreases due to uncertainty should self-correct when the uncertainty dissipates.

Conversely, a decrease in population, decrease in the division of labor, decrease in consumer choice or decrease in uncertainty should all result in an increase in real prices, even with a conserved money supply.

Clayton