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If every person in America was given a million dollars what fundamentally changes that causes prices to rise? Intuitively I was thinking that this is simply a production problem. With more money there is more effective demand but without a rise in productivity prices will simply shift to a new equilibrium.

I had this thought and I was wondering if it's a good way to understand inflation.

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  • $\begingroup$ You are right. It is a good way to understand inflation. Even when people are talking about quantitative easing (QE) or reductions in official cash rates (RCR), the final (average) point is always an inadequacy between supplies and demands, e.g. if your production system is reactive you will get no inflation, which is equivalent to your conclusion. QE/RCR means cheaper debt, which means stimulated demands here and there and, finally, at constant levels of supply, it means higher eq. prices. $\endgroup$
    – keepAlive
    Jul 19 '18 at 7:14
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Yes, this appears to be correct. This intuition is fundamentally Keynesian.

Consider the AS-AD curve. During the vertical portion, additional demand increases prices while supply remains roughly fixed. As a result, prices increase dramatically.

https://en.wikipedia.org/wiki/AD%E2%80%93AS_model

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  • $\begingroup$ This is a short answer that would serve well enough on say an undergraduate homework assignment. However, it is nowhere near adequate as an answer to OP's question. $\endgroup$
    – user18
    Jul 19 '18 at 1:01
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You can't only view it through the lens of the amount of production. You're missing more than half the story.

Inflation is sometimes described as too much money chasing too few goods.

More specifically, it can be a change in the balance between the amount of money and the amount of goods and services, such that there's some combination of more money, and less goods and services.

So yes, a reduction in production is one possible cause of inflation. An increase in the supply of money is another.

Money doesn't have value in and of itself. Its value comes from its scarcity, (and its credibility, its usefulness as a medium of exchange and a store of value, and so on)

If that scarcity is reduced (by creating enough money to give each person a million dollars, and then doing that), then its unit value decreases a lot - the scarcity value of a single dollar has just hugely decreased. In other words, each unit of production (of a good or a service) can now be exchanged for a lot more dollars. That is to say prices rise, and we have inflation.

Inflation is about the amount of production, the amount of money, the changes in each of those, the interaction between the two amounts, and the interaction between the changes in the two amounts. Inflation is also about the accumulated expectations of the market, of the future of all of those things. It can also be about changes in the balance between the production of different types of goods and services; and changes in the composition of the basket of goods and services that are used to measure inflation. And it can be about changes in the method of calculating inflation.

So that's why it's much more interesting and complex than merely the amount of production.

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