Ok I get inflation raises prices due to the devaluing of currency…and I get that prices are set by subjective premises of individuals but how do these two come together? How do prices fluctuate due to inflation yet also do to subjective value?
As the amount of money in the economy increases, the marginal utility of said money decreases. This means that the actor gaining extra units of money is increasingly willing to part with some of the extra money in order to exchange for widgets. At least if there are no drastic changes in her preferences.
This new demand drives up the price of said widget. The Widgeteer then, given his increased income, purchases other goods and services. This leads to the incrementally rising prices in the economy, as the new money ripples through to the further layers of the economy.
There’s obviously more to it, but that’s the crux of it.
Essentially what happens is that if one assumes fixed value scales on behalf of consumers, as the new money enters the economy they’ll find themselves with excess supplies of money and attempt to dishoard. Of course, as they spend this excess balance on goods and services the suppliers will intepret this as extra demand and consequently raise their prices.
Essentiallly the raising of prices will mean that consumers will increase their demand for money and whilst prices will still continue to rise as there is more money in circulation than is being demanded by consumers eventually the demand for, and supply of money will come into equilibrium through the rising of prices.
Of course, this is assuming that the initial increase in M is not a response to a prior change in money demand.
I have always liked LVM’s explanation as found in “The Theory of Money and Credit” , because it is so simple, and makes so much sense- at least to me [:)].
He points out that money [ i.e.paper money, " fiat currencies", " fiduciary media" etc.] is merely a commodity, albeit one with a negligible , close to zero cost of production.
Just like any other commodity it is therefor subject to the laws of supply and demand [a.k.a . the subjective valuations of individuals]; therefor its actual value at any point in time [i.e real world, market value, as opposed to the denomination printed on it- $1, $5, $100 etc.], just like any other commodity, is always ultimately set by the final outcome of the interplay of the two factors, supply, and the demand for that supply.
“Inflation” is the term for a result, the end result of the supply/demand equation wherein the broad mass of individuals have [individually and subjectively] decided that the paper money produced is worth less to each of them than the broad mass of other goods /commodities available to them, so they decide to hold less $'s .
“Deflation” is the opposite; the broad mass of individuals have [individually/ subjectively] increased their (e)valuation of paper currency relative to other goods/commodities [for whatever reason], and desire to hold on to more [$'s] than they did [collectively] previously.
Although increasing the money supply may cause inflation, it is not a foregone conclusion simply because demand for that supply can never be anticipated.
For example, if demand for money consistently outpaces the increased supply [of newly created money] , deflation [i.e increased consumer valuation of paper money] , will still result.
Conversely, if the money supply is decreased [less issued], but the demand for that decreasing supply drops even faster, inflation [i.e decreased consumer valuation of each $], would still result.