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Studying for a test? Prepare with these 5 lessons on Inflation.
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Video transcript
So in a normal economy we know that employment will drive overall demand. If we have high employment or low unemployment, then people are going to have more jobs, and they're going to have higher wages, and that will have higher demand. Or if the other way goes around, if they lose their jobs, demand is going to go down, wages will start to go down, and people aren't going to have money in their pockets. So employment drives demand. And we can view the demand-- and I'm making a huge simplification here-- demand will drive production. Or maybe we could think of it as supply. It'll drive supply, and it can also be a driver of price. And of course, there is a little bit of a negative feedback loop for both of these things. If the demand is high and the price goes high, that might produce a little bit of negative feedback on the demand. Instead of an arrow, this line here means negative feedback. I'll put a little negative sign here. And let's say the demand is high and then the supply goes high. Well actually, the supply going high would drive the price going down. So maybe I should draw a negative feedback like here. High supply would mean lower price. But that's not what I want to focus on in that video. And we could keep adding more lines here. But this is roughly simple take on it. But the general idea is supply and price will then drive corporate profits, or just profits in general, even for an individual business owner. And then profits are going to drive employment. Now, let's imagine a scenario. We are in a bad economy, maybe a depression-like economy. So in that situation, you could start really at any point in this circle. I'll just start at employment. So let's say employment is really low. That's going to make demand really low. And if demand is really low, then supply is going to go down, and price is going to go down. And then that's going to make profits go down. And that's going to make employment even lower. And so what we find ourselves in this kind of recessionary or depression area environment, this would be called a deflationary spiral. And it's a spiral because a bad economy is driving lower prices, which is in turn driving a bad economy. And to make matters worse, if this continues long enough, or if these price declines are severe enough, you could imagine people saying, look, I have this dollar in my pocket. I'm not going to spend this dollar because, one, I might lose my job at any moment, and I know that that dollar is becoming more powerful, that I can buy more every minute that I wait. So as the price goes down, so as all of this scary stuff happens-- so the employment is going down, profits are going down, prices going down-- this makes people not hoard goods the way that they would do in an inflationary spiral. But it makes them hoard money. And why it's ultra scary for central bankers or for governments is they start to not have as much control over the economy. They can't just run the printing press and try to stimulate the economy in this situation, because if they did people are so conservative right now-- You could imagine maybe a depression is going on for years and years and years. And let's say that they take some type of a helicopter-- And this isn't how you actually distribute money to the money supply, but it's just to show an extreme example. So they take a helicopter, and they start dumping cash on people. They print cash, and they start dumping it on people. So every man, woman, and child in the country gets a $10 bill. Well, if people are really scared and really afraid, they're just going to take that $10 bill and stuff it into their mattress, and it's not going to change anything. That dollar isn't going to actually enter into the money supply. The velocity on it will be 0.