Inflation Is NOT Price Goes Up: Common Misconception

   

If there is one thing that you need to know from ‘macro economics’ world, it is “inflation“. Contrary to popular believe, this word have no direct impact to our day to day life.  But why people talk about this every day as if it’s a food or something? The reason is there is common misconception about the meaning of “inflation”. I  explain in plain english that even a primary school student will never ever misunderstood this ever again. And by understanding it, you will see your finance position like you never seen it before !

Definition of Inflation

“Inflation” derived from “inflate” means ‘ to expand or increase‘… What’s expanded/increased ? the economy… In more direct meaning: the sum of money is the one increased/expanded…. How the money got increased ? Some of the ways:

• Government can print some more money.
• New debt is created: for example if the bank give you a new credit card with $6000 limit, then suddenly there is additional $6000 money in the economy (you can spend that debt ‘money’ on anything). Well, imagine if there is 1000 person who got the credit card. The cumulative, there will be $6million additional money in the economy/market.
  
• More money from overseas because they import goods/service from us.  Of course this is have to be subtracted with the money that send overseas because we import stuff from them.

So, nothing to do with the price of anything at all….

Economy Goes Up

The Effect of Inflation

Now, if we have inflation (means more money is available), what happen with the price? It can goes up and down or stay the same depended on the supply. Let see the example below: say there are 5 persons want to buy a Plasma TV. The price of the TV is $3000.

1. Initial Condition: None of them got extra money to buy the TV so, they just pass the shop window with ‘that’ look. Now suddenly all of these people have extra $6000 in their pocket.  Then they all now wants that $3000 TV
2. Condition 1: Unfortunately that’s the only TV left. So, what happen with the price of the TV ? Of course it will go up. Why? Say, a person goes there and tell the shop that he will buy that TV for $3000 as price. But then the 2nd person can make a better offer, say he will buy it for $3500. (Remember that’s the only TV and each of this person have additional $6000 inside their pocket).. and so on. At the end: the TV will be sold with higher price.
3. Condition 2: The shop owner knows about these 5 people, and he quitely make another order and have 5 more TV on the shop so each can have one and the shop will have a nice sale of 5 x $3000. So the price of the TV will neither go up or down.
4. Condition 3: Apparently another shop owner cross the street know about these people too hence he also make an order of the same exact TV to be available in his shop. Not only that since he knows there are potential 5 people who buy and he has to compete with the other shop, he need to decrease the price, say to $2800. He put the big banner in front of the shop. Now these 5 people will likely to buy the cheaper price, hence the first owner will need to decrease the price to match his competitor. (Otherwise all the customer will buy from across the street). But at th end the TV will be sold with lower price.

So the same thing with the economy: even there is an inflation (increase of the amount of money) if the availability of goods are also increased (have more food, more petrol, more TV, more furniture, more houses..etc) then the price will not go up. If the inflation and product growth are in balance, the price will be around the same number.

In another word: the price is not necessarily goes up if there is inflation, it will be fully depended with the supply of the product/goods. The increase of price is only of of the possible effect of inflation.

Inflation on Your Personal Finance

If there is inflation, the only ‘concern’ is when the price goes up with it. This is where inflation makes the value of your money decreasing. Just like ‘Condition 4′ on example above:  for the same exact thing you pay higher price, means the money is not as powerful as before -or- it’s value is decreasing.

In this case, if you have a lot of debt, inflation could be a good thing as you actually pay back the loan with less value in it – i.e: you payback the loan/debt cheaper because of this inflation effect.

Conclusion

The movement of the price (up, down or the same) is the effect of inflation but not inflation itself. And considering the effect, inflation is not neccessarily always a bad thing for everybody.

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Denis Kristanda  

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