Inflation and prices

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I was having a discussion on Twitter today about minimum wage. I was arguing that minimum wage should not be raised and should not even exist at all since it does not solve the root causes of why it’s even considered necessary in the first place. That root cause is inflation. But there are many times when I bring this up—and not just on Twitter today—it becomes clear to me that a lot of people just don’t understand what it is.

Inflation occurs when there is an artificial increase in the monetary supply (like the Federal Reserve’s quantitative easing policies) or there is an increase in credit (such as when a bubble grows). Each of these situations puts more dollars into the economy, so as a result, the purchasing power of each dollar decreases. If there is a period of inflation and your wage remains the same, your economic position drops.

There are people who believe that an increase in demand will lead to higher prices. When all else is equal, this will be true. But this assumes that supply remains static. In practice, a business can usually make more money if it sells more units, so there might be an incentive to lower prices so that consumers purchase more units as seen in the law of demand. Furthermore, when there’s competition among suppliers, there will be a downward pressure on prices to attract consumers.

This does not guarantee prices will go in either direction, but if inflation were to be considered to be occurring due to an increase in prices, then that would mean that the majority of prices across industries would need to be on the rise.

hd-cost-graphThe other aspect that the price-inflation advocates seem to miss is that technological advancements make production more efficient. In other words, technology makes it cheaper to make things. Consider transportation. What would be more expensive: transporting goods from one side of the country to the other via airplane or horse and buggy? If it weren’t more efficient (read: profitable) for a business to transition from horse and buddy all the way to airplane, why would they do it?

Maybe a better example would be the cost of hard drives over the years. In thirty years, the price of a hard drive per gigabyte dropped by a factor of about 1,000,000. Remember 3-1/2-inch floppy disks? They could hold 1.44 MB. I can buy a 32 GB micro SD card, which is the card in my phone right now, for about $10. Speaking of phones, nearly everyone owns a smartphone nowadays. That wasn’t the case ten years ago. It’s certainly not because they’ve become less affordable.

Economics is based on some simple concepts, but it’s important to understand how those concepts work and how they interact. If you don’t, it can lead you to some incorrect conclusions.