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My understanding is : If production increases, it would imply the amount of goods increases as well for the same amount of money available in the market. Because of this, we should see prices of goods decrease as the offer got bigger.

Since we say inflation increases with GDP growth, where am I wrong thinking it should be the other way around?

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  • $\begingroup$ Nice question! I think none of the current answers really get it right. My intuition would be to distinguish between the sources of growth. If you have growth due to technological (supply side) improvements we should indeed see falling prices if the money supply remains the same. However, if technology is unchanged but there is demand driven growth then for a fixed money supply we should see higher inflation. One would need to spell this out in a general equilibrium model (with sticky prices?) to make this a proper answer, which is why I posted this as a comment only. $\endgroup$ – HRSE Nov 19 '15 at 10:21
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GDP growth would lead to deflation if the money supply remained unchanged. The government usually increases money supply as the economy grows to avoid deflation. Controlling money supply is not an easy task though because the economy responds with lag to every policy decision. But ideally, the government aims at keeping inflation low (1-4%) and avoiding deflation. Zero inflation is also undesirable because if you know your money will be worth just as much a year from now, you have less incentive to invest.

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Inflation $$\frac{P_1-P_0}{P_0}$$

Where $P_t$ is the price level at time $t$

This formula is just the percentage change in price.

GDP Growth From Investopedia:

A measure of economic growth from one period to another expressed as a percentage and adjusted for inflation (i.e. expressed in real as opposed to nominal terms). The real economic growth rate is a measure of the rate of change that a nation's gross domestic product (GDP) experiences from one year to another.

So inflation concerns itself with the changes in prices over time. Price can be measured by something like the CPI (consumer price index). GDP on the other hand focusses on what can be produced. If you look at the definition, you can see that in calculation real GDP, the inflation rate is essential. Real GDP is GDP controlled for inflation Useful when comparing different years.

An increase in inflation can be a driver for increased nominal GDP but not for increased real GDP.

This site provides a pretty solid background and isn't too hard to folow..

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