FEBRUARY 18
Why Prices Rise
When More Money Chases the Same Amount of Stuff
The Signal
Prices are pushed higher when spending power grows faster than the things available to buy.
The Reading
Imagine a town with ten families and ten baskets of food. Each family has enough money to buy one basket. Nobody needs to fight over dinner. Now imagine the families have more money to spend, but the town still has only ten baskets.
The families are richer in dollars. The town is not richer in food. What happens? People can offer more for the same baskets. Sellers see buyers are able to pay more, so prices can rise.
Now reverse it. Keep the money the same, but a flood destroys half the food. Ten families are competing for five baskets. Again, there is too much buying power chasing too little stuff. Prices can rise.
That is the simple idea behind much of inflation. Yesterday we learned that bank lending can create new spendable money. Creating more money does not automatically create more houses, food, electricity, cars, doctors or building materials. If spending power grows faster than the economy can produce those things, prices can rise. Money is not the only cause. Prices can also rise because there is less stuff available. Floods can destroy crops. Wars can disrupt energy supplies. Broken supply chains can make goods harder and more expensive to produce.
Remember the picture: prices can be pushed up because people have more power to spend, because there is less available to buy, or because both happen together.
A great example is rideshare pricing. When plenty of cars are available, fares stay low. When thousands of people suddenly need a ride at once, demand overwhelms supply and fares can soar, yet people still pay because the limited rides are competing for their money.
Money can create the power to demand something. It cannot create the thing being demanded.
First Principles
More spending power competing for limited goods and services can push prices higher.
Prices can also rise when supply falls or production becomes more expensive.
Creating more money does not automatically create more goods and services.
Today’s Challenge
Place five objects on a table. Apples, pens or biscuits will do. Imagine five people each have $1. Now imagine each has $10, but you cannot add another object.
What changed: the amount of stuff, or the amount people could offer for it?
Now remove three objects. What happens to the competition for the two that remain?
Tomorrow’s Signal
The Cost of Cheap Money