Lets play a little imaginary economic game to figure out why prices really go up and down and what we could do to stabise them. We will ignore some of the current accepted explanations, Supply and Demand, monetarism, money printing, in order to see through the mist of memes to find a little truth.

Scenario 1

We’ll start with 4 players all selling different products that they all need. They agree to use a simple means of exchange called a dollar, they will exchange their goods for dollars and they all agree to accept dollars for their goods. We’ll call them:

Java who sells coffee

Melbourne who sells toast

Brisbane who sells Avocados

Wellington who sells milk

A unit of each product costs $1 so Java sells the other three a coffee and gets $3 enough to buy one toast, avocado and milk. Likewise they can all do the same and have a nice breakfast.

One day Melbourne gets a bit greedy and decides to charge $2 for coffee, this way they can collect $6, still get a full breakfast and save the other $3.

The other three think this is extremely unfair and not in the spirit of the agreed exchange system, so they double their prices to, and all goes back to normal. Each gets enough to afford a full breakfast and no-one saves or goes without. Melbourne tries again, and again they all raise their prices. 

Technically this is inflation but it does no harm, it actually keeps greed in check.  If Mebourne kept trying to rip the others off they would need to come to a new agreement – a new currency or cease trading.

Let’s make it a bit more real life.

Scenario 2

We will add:

Cayman who can create money and lend it at interest. – a bank

Bangladesh who sells their labour

To start the game Caymen lends everybody $10 but they want $20 (interest) back after breakfast which will make it $50, enough to also buy breakfast

Java sells the coffee for $10

Brisbane the avocado for $10

Melbourne the toast for $10

Wellington the milk for $10

Bangladesh makes and serves it for $10

They each collect $50 and spend $50 and everyone’s happy. 

Again Melbourne doubles their price and Brisbane, Java and Wellington follow but instead of doubling their price Bangladesh worries that the others will serve their own breakfast (Bangladesh was serving the breakfasts) so keeps it at $10. Cayman offers to lend Bangladesh the extra $40 if they still need the whole breakfast, but they will need to pay back  $10 + the interest of $10 + $40 plus interest of $40 a total of $100.

Java, Brisbane, Wellington and Mebourne all have an extra $10 which Cayman says they will borrow from them and give them $5 interest. This is so Cayman can balance their books.

The only way for Bangladesh to pay back the money is to borrow more. This increases money supply. So the cause of inflation and increased money supply is not a hyperactive economy or a mismatch of production and wages (efficiency) but rather greed and fear.

In this scenario a central bank would raise interest rates to decrease money. This puts Bangladesh in further debt and forcing them to borrow more to get what they need. It would  give more money to those putting up prices, rewarding their behaviour. Greed is not punished but rewarded.

We could tax those with savings and give the money to those without but that would be difficult. The best way would be to introduce a new agreement on exchange and not allow the bank to create more money at interest.

Scenario 3

Let’s make it a bit more like our current situation, and add some choice.

Dubai sells energy and all the others must have energy to supply their product or service. However people only need one type of food and they can make it themselves.

Dubai doubles its price from $5 to $10 so in order to cover the extra cost everyone puts up their prices by $5 and Cayman raises the interest rates by $5 in order to still afford breakfast, but that means each player now needs to pay back more interest, including Dubai, so they raise prices again and we are in an interest rate – inflation spiral until everyone loses faith in the currency.

Bizarrely our solution to this is to encourage interest rate rises essentially until the economy collapses. 

The other option is people start making choices, they decide to live on self made toast so Bangladesh, Wellington and Java all starve while Melbourne, Dubai and Cayman get rich.

Deflation

Deflation is supposed to be really bad as well. That is why our central banks aim for 1-5% inflation. I’ll have to Google why:

• Most of the time, deflation is unambiguously a positive trend for the economy, but it can also under certain conditions occur along with a contraction in the economy. 
• In an economy dominated by debt-fueled asset price bubbles, deflation can lead to a temporary financial crisis and a period of liquidation of speculative investment known as debt deflation.

So Google says… no.

It is only when people stop spending and investing because their money will be worth more tomorrow and the economy essentially stops functioning. Let’s face it people will still grow food and eat because we need to. 

Central banks probably keep inflation running at 1-5% to ensure people with assets make profit and people who work for a living need to keep striving and begging to maintain spendability on their wages.

S&D

So why do we always hear about supply and demand when prices go up and down? That’s because people believe in a theory that supply and demand should affect prices and some sellers use this belief as an excuse to raise or lower prices. There is little reason to change your price depending on the amount you have of something or the amount of people wanting to buy it. With some perishables you could argue if you can’t store them you should lower the price to sell them instead of letting them waste  but that isn’t very common. 

Also if their is a crowd trying to buy your scones you could chare more and make more money per scone, be greedy, or you could just serve the queue and those that miss out, missout.

The argument for S&D is that those that want it most, or need it most will go without other things to get the item in short supply, thus S&D supplies the most needy and encourages more sellers into the market to seek these premium gains.

I remember hearing from a green grocer on TV talking about lettuce prices in 2022  after supply dried up due to floods (pun intended ;-)). A lettuce cost $10 or more and the interviewer asked if he was selling them, and he said no. Essentially they ended up being thrown out. Makes no sense. The price was jacked up because supply was low and in theory it means those that want it the most get it because they are willing to pay the higher price – this is nonsense in an unequal world though – but if no-ones buying them why not just sell to those who come first at a low price. It’s the belief in S&D that actually causes a lot of price movements when it really has no effect in the real world.

What have we learnt?

Banks creating money and charging interest is not a way to create a stable currency. 

Raising interest rates can encourage inflation by rewarding greed, protecting savings, and causing cost increase price spirals.

Taxes and payments could be used but politicians hate annoying rich people.

Most of our tools only work by hurting non-rich people and breaking the economy.

I’ve written a book and some articles on real solutions. Yay