How to think about inflation

A good old fashioned model of inflation fit for modern times, including a little entertainment for a rainy day.

Economists work with models, toy versions of the world that us limited humans can hope to understand. Perhaps the best known example is the framework of supply and demand. It consists of a downward sloping demand curve and an upward sloping supply curve. That seems like a simple enough model to use, right? It is, so long as you understand the difference between a movement along a curve and the movement of a curve.

Economic models

Supply and demand deals with individual markets, like the market for corn. The corn market is, when you think about it carefully, horribly complicated. And yet the supply and demand framework helps us to think about its most important features in a relatively simple, structured way. But while corn prices may be on our minds right now, inflation definitely is.

This brings us to the subject of the entire economy. How do economists think about that? In principle, if you add up all the individual supply and demand curves for all the markets in an economy you arrive at a total. Call these totals aggregate supply and aggregate demand. Except no one does that, because even with super computers, it gets very complicated. Which brings us back to models. The advantage of a simple model is that it allows us to understand some aspect of reality quickly and easily.

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