Inflation can be caused by either supply or demand

Inflation can be caused by either supply or demand

November 12, 2020

Inflation is a term used for something getting bigger. Thanksgiving is a time for humans to expand with the consumption of a big meal. Hot air balloons inflate when warm air is added.  The cost of goods and services also increase, but sometimes for different reasons. 

Supply inflation occurs when money is printed and injected into an economic system: Two people were on a cruise when the boat sank near a small island. The island only had one palm tree with two coconuts. The husband makes it to shore and discovers $2 in his wallet. How much are the coconuts worth? One dollar each! His wife also makes it to shore and discovers $2 in her purse. What are the coconuts now worth? Two dollars, or 100% inflation, caused by the increase in money supply. Governments can cause supply inflation by printing too much money.

The second type of inflation is demand driven. Five friends go every weekend to get ice cream. The shop never has enough ice cream except to make four cones. The friends bid among each other to see who gets the ice cream and pay more than the listed price. This is demand inflation and is remedied by the supply of more ice cream to bring the price back down.  Demand inflation usually leads to a growing economy providing the goods and services the citizens’ demand. There is good and bad inflation, just like cholesterol.

This is a hypothetical example and is not representative of any specific investment. Your results may vary.