September 10, 2014

Philippines: The Story of Inflation

The prices of goods in the Philippines has started to increased significantly. The concern of people, specially those with lower income, is that the number of goods in their market basket are getting fewer.

People believed that the prices of basic goods should be regulated. Yet, what if the despite the protest, prices keep increasing?

Let me tell you a story on how price increase (inflation) happens. The basic cause of inflation is increased in demand for a specific good (supply shocks can also impact the price in some cases). Imagine that there is a cake, only those who have money can buy a cake. The cake was divided into ten. There were twenty people in the town, only ten of them have jobs and can buy a cake. The ten people shared equally on the price of cake. After a year, a young man graduated from college and found a job. After earning, he decides to reward himself with a cake – because he has not eaten a cake. However, the cake can only be divided into ten, now there are eleven of them who wants to eat the cake. The baker got curious and asked himself; "what will happen if I doubled the price of cake"? The baker said, “I'm doubling the price of cake”. eleven man said, “it's okay we will still buy it”. The young man was not able to get a share since there are only ten slices of cake. The next day, the baker announced that he is tripling the price of cake. The young man, because of his curiosity, was the first to said “yes I'm still buying it”! The other ten man pause for a while; two man said “we think that is too much, we are not going to buy”. The other eight said, “we are going to buy”. The two loyal customers left the bakeshop, now there are only nine of them sharing for ten pieces of cake. The baker realized at the end of the day that he earned a lot from new combination of nine customers rather than the previous combination of ten; and, he was able to eat the last piece of cake.

The above scenario is an example of price increase. If the demand did not increased, the baker might not thought of increasing the price. In the economy, there are new graduates, like in the above example, that will buy a good even if the price is high – because they want the new experience and already have the money. On one hand, from previous mass production (baking as many cakes as possible to earn) the baker become profit oriented; he now knows that he can earn more even if he is producing less.

You might asked, what if after the announcement none of the customers bought the cake? Surely, after a week or month, price will go down. In this case, the decline in demand will trigger the price down.

In the long run, supply of goods are fixed, too much consumption can push the price up. By consuming the right amount of goods, you are helping the economy, the low income people, and your savings account.

In present, notice that prices of foods are increasing while prices of clothes are declining (on sale), think about it, think about the above scenario.

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