Tuesday, 26 January 2010

The Economic Climate (5): Inflation in a hot economy

The main worry is that a hot economy and too much prosperity will lead to inflation - the technical term for prices going up. 
  • Demand for goods and services is high, which leads to a shortage of raw materials, and possibly a shortage of workers. 
  • Whenever there's a shortage of anything, the prices tend to go up. 
  • Car manufacturers are paying more for steel, aluminum, and so forth, so they raise the prices of cars. 
  • When employees begin to feel the pinch of higher prices, they demand higher wages.

One price hike leads to another, as businesses and workers take turns trying to match the latest increase. 
  • Companies are paying more for electricity, raw materials, and workers. 
  • Workers take home bigger paychecks but they lose the advantage because everything they buy is more expensive than it used to be. 
  • Landlords are raising rents to cover their increased costs. 
Pretty soon, inflation is out of control and prices are rising at 5%, 10%, or in extreme cases, upwards of 20% a year.  From 1979 to 1981, United States had double-digit annual inflation.

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