The Hidden Factor for Determining Inflation: The Quantity Factor

by Stephan Smith on March 1, 2011

Whenever the money supply of an economy increases at a faster rate than the supply and consumption of goods and services, inflation manifests. Inflation is usually calculated by economists and various other statisticians by assessing price changes for goods and services. If there is a total overall increase in the prices for goods and services, then an economy is deemed to be experiencing inflation. If there is a total overall decrease of prices for goods and services, then an economy is deemed to be experiencing deflation.

But simply looking at the prices of a good or a service isn’t sufficient to determine inflation. To get a better gauge of inflation, there is another factor that must be addressed. Due to the fact that this key factor can be easily over looked by economists and other statisticians, ‘this’ factor is commonly hidden and therefore not addressed. And because it is not addressed, a less accurate picture of inflation is formed. No more! I will attempt to reveal, ‘The Hidden Inflation‘.

Let’s start off with an overview of inflation. If you aren’t sure what inflation is or if you just want to be refreshed, then please take this time to check out my explanation on inflation. Great, now that you have a good grasp on inflation, its now time to reveal the hidden factor that many professionals and even government agencies may look over. The hidden factor involves changes in the quantity of a good or service.

You see, many analysts only factor in changes in the prices of goods and services when trying to assess inflation. But there are many cases where producers don’t change the price of a good or service, but rather, they may change the quantity of goods and services offered and thus quietly and very discreetly change the price paid per good or service without changing the overall total. I hope you grasp the concept I am trying to convey.

For more clarification, consider this example. Let’s pretend I’m a florist and my business is selling roses. As a starting point, let’s say that I sell a package of 12 roses for $20 United States dollars. Here are the rules. I only sell 12 roses at a time. If you want to buy from me, you can only buy 12 roses at a time and the going rate is $20 dollars per 12 (or dozen). As time passes, let’s say my costs have gone up due to inflation. Now I can no longer afford to sell 12 roses for $20.

The most popular solution is to increase the selling price of the 12 roses. If I decided to charge $25 instead of $20, then I may be able to cover my expenses and make a profit. Most economists and statisticians account for that type of price increase when trying to calculate inflation. The other way of increasing the selling price of my roses is to change the quantity of roses I sell. Instead of selling 12 for $20, I can sell 10 for $20.

By lowering the quantity of the goods (roses) that I sell, I am raising the price. When producers make changes like this, it is usually less noticeable. It is less noticeable to consumers who buy the goods and services and it is less noticeable to those who try to keep track of inflation. That is why I dub it the ‘Hidden Factor for Determining Inflation’.

Think about it. You go into your favorite store to buy some of your favorite chips. For years you’ve been buying your chips at your store. Let’s say you’ve been paying $5.50 for those chips. Without you noticing, it is written on the bag that your chips has a net weight of 50 grams. That weight serves as the quantity of the good. But one day, the net weight changes from 50 grams to 48.3 grams and the chips are still selling at $5.50. The quantity of your chips has decreased but the grand total price remains the same. Boom, you just been hit with inflation. And in the real world, you most likely wouldn’t even notice. That includes the analysis, economists, government officials and whoever else.

So when you are reading reports on inflation, do not forget to ask yourself whether or not that report takes the quantity factor into consideration. Knowing that would aid in determining the accuracy of the report.

The Money Supply and the Quantity Factor

Let’s step back for a second. I want you to think about money…the very currency in your pocket. How much do you have in your possession? Twenty dollars? Sixty dollars? One hundred? When compared to the money that was in circulation in the early 1900’s, is the money in your possession worth more or less? I would very confidently in say less. One hundred dollars in the early 1900’s was more valuable than one hundred dollars today. How do I determine value? I determine value in this case by how much goods and services you can buy. One hundred dollars can buy you a lot more goods and service in the early 1900s than today.

Have you ever wondered why? It comes down to the quantity factor. There was way less money in circulation in the early 1900’s then there is today. Remember the example about the roses I gave earlier in this post. When there were less roses offered for $20, each individual roses became more expensive. Same with money in general. When less currency is in circulation, currency becomes more valuable. When more currency is available then currency become less valuable.

Which leads me to my final point. The money supply of an economy is the quantity factor of a currency. The more currency that is stuffed into an economy, the less valuable the currency will become. Going back to my example earlier. The more roses offered for $20 dollars, the less expensive each individual rose will become. So let me reiterate…one…more…time. The money supply of an economy is the quantity factor of a currency. Fluctuations in the quantity of currency will lead to fluctuations in the valuation of the currency.



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{ 2 comments… read them below or add one }

Dotty April 11, 2011 at 2:32 PM

Glad I’ve finally found something I agree with!

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Stephan Smith April 11, 2011 at 2:40 PM

Thanks Dotty for stopping by.

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