What is inflation?

Inflation is a sustained increase in the overall level of prices, usually measured as a yearly percentage. It matters because it reduces the buying power of savings and wages unless they rise at the same pace, and because uncertainty about it distorts planning.

How it works

Prices rise generally when demand for goods grows faster than supply, when producers' costs increase, or when more money chases the same goods. Expectations add a feedback loop: if people expect higher prices, workers ask for higher wages and firms raise prices in advance, which produces the inflation they expected.

The effect on real value is simple. If prices rise by a rate i, then an amount of money loses buying power by about i each year, so a fixed sum is worth less over time. Savers and lenders at fixed rates lose, while borrowers at fixed rates gain, because repayment is made with cheaper money.

Example

Say a basket of goods costs 100 today and prices rise 5 percent per year. After one year it costs 105, and after two years 100 times 1.05 times 1.05, or 110.25. A worker earning 1,000 a month with no raise can buy 1,000 divided by 1.1025, or about 907 in today's money after two years. A raise of 5 percent a year would hold buying power steady. The rate is an illustration.

How to model it in Machinations

Create a Pool for the price level with a Source that adds growth each step at a rate set by a Register. Make that Register depend on a Pool of money and on a Lever for expectations through state connections. Add a Pool for a household's savings and a Register for its real value. Play with the inflation Lever at 0 and at 5 percent and chart the real value of savings.