Inflation and Assignation

Something that is interesting to see is that if there were inflation and all the prices instantly doubled, the people would choose exactly the same amount of all the goods as they did before.

The logic behind this result means that if a person’s income doubles at the same time that the prices double, nothing would have changed at all really. This means that a person would still be able to buy the same amount of goods and services that they were used to buying before inflation and given that these quantities were the ones that maximized your utility before, they would continue to maximize utility afterwards as well. As a result, you can erroneously conclude that inflation does not matter.

There are however, terrible things that can come about due to inflation. These horrors are caused by the fact that in real life, you never see a perfect inflation in which the prices of all the goods and services increase exactly in the same amount and exactly at the same time.

To the contrary, what occurs is that the prices of the different goods and services increase at different rates, so the fractions in the equations become completely unstable because the denominators change to different rates and when this happens, people start to adjust the demanded amounts drastically to try to establish equality in all the marginal utilities per dollar. As this process takes place, it ends up in chaos; some companies start to diminish demand for their products, while others see them increase.

In real life, inflation is not something that should not concern people, because it does matter and can cause serious problems.