I now have a 20 minute to and from work. My drive into work is often filled thoughts of what I need to accomplish for the day and trying to plan out my day. My drive home however, is often filled with a jumble of thoughts about a variety of different topics. On my mind the last few days has been inflation, the semantics behind it, and why people need to understand it. This post is written to be as interesting and as easy to follow as possible.
Inflation is often described as the cost of items going up. The candy bar that cost my parents a nickle, and used to cost me 50 cents, now costs 80 cents at the vending machine at work. Did the value of that candy bar actually increase 16 fold? In a word, no.
Let's take a simple example, maybe... a shoe box. We'll even put shoes in it. Let's say this shoebox/shoe combo can be purchased today for $10. Next year, the same shoebox/shoe combo can be purchased for $12. So, did we have 20% inflation? In a word, maybe.
It behooves us to decide what we actually mean by inflation. To do so, we're going to introduce a third object of value to the above hypothetical situation. In case you missed it, the two objects of value in the example were not the shoebox and the shoe. The two objects were the shoebox/shoe combo and the dollars you were willing to trade for the shoe/shoebox. Our third object is nothing more than a datum of value. Today object 3 has a value of $10. Next year object 3 have a value of $10 from today and and subsequently the same value as the shoe/shoebox from today. This is an important distinction.
Next year however, a shoe/shoebox combo costs $12. One of two things has happened. Possibly both. The value of the shoe/shoebox combo has risen in relation to object 3, or the value of the money used to buy the shoe/shoebox combo has decreased, thus requiring more of it. This is where the semantics of inflation comes in.
Inflation is the change in value of the money, not the products.
This post is not here to debate whether or not inflation is good, but what inflation is. I welcome any thoughts supporting or opposing to what I have posted here.
1 comment:
The way I like to explain it is that my house is worth X gallons of milk. When the price of milk goes up twofold, then the house is worth X/2 gallons of milk. (This happens fairly often if you're pricing using the horrible grocery store that's a block away from our house.) When it goes back to normal the house is worth X gallons of milk again. This massive yo-yoing of house values is pretty consistent. (I wish I could figure out how to hedge against the relative movements) Now, the brainteaser question is, which of the two changes was inflation and which was deflation?
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