Moderate inflation in a good economy | Inflation | Finance & Capital Markets | Khan Academy

ruticker 07.03.2025 23:39:00

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Any economy is a super complicated thing. So, what I'm going to do in this video is a super oversimplification, but it's just a way for thinking about things. In particular, I want to think about why good economies tend to be associated with a moderate level of inflation. That will also help inform us when we start thinking about stagflation, when we have inflation with a bad economy. In a good economy, employment is up. Because employment is up, employees have more negotiating power. There are more people who want to hire them, and there are fewer people who want their jobs. As a result, wages will go up. Since you have more people with jobs and those that have jobs are getting paid more, you can imagine that demand would also go up. There are just more people with money in their pockets. If demand goes up, then companies—or if you think of it as factories, but it could also be services—will be utilized more. If things are utilized more, then the companies or those factories, or whatever you want to think of them, are going to have more profit. On top of that, if they get close to full utilization, or if they see that full utilization is down the road, they're going to want to invest more. They could actually push off that full utilization and still get more profit by maybe raising prices. This is where that moderate level of inflation really shows up. In fact, if there's more demand, a factory can produce a little bit more, and it could raise prices a little bit more. So, this is where the moderate level of inflation shows up. There is a little bit of a negative feedback loop: if prices go up, it will inhibit demand a little bit, and that's why it's moderate inflation. We're not talking about some type of crazy inflationary spiral here. But the net effect of more utilization and more investment is going to be an increase in supply. It's going to be an increase in supply, and once again, and this is kind of Econ 101, if supply goes up, that would also have a bit of an inhibiting impact on price. Let me draw a little bit of a diagram so we get all the feedback loops over here. So, this is negative feedback right over there. But to complete the loop, if we're investing more, we're going to build more factories or some more capacity to do services or whatever else. That's going to increase employment. If we have more profit, then a company feels better about growing; it feels like it has more of a cushion and feels more optimistic about the future. That's going to help employment. And obviously, if we run the factory lines longer, we're going to need more people to run those lines, so that also will increase employment. This is just the general kind of feedback loop. You can add a little nuance twist to this, but this is the general idea of why a moderate level of inflation is kind of associated with what I would call a pretty virtuous cycle that we would normally see in a good economy.

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