The supply and demand causes of inflation

Dear Dr. Universe,

How is inflation caused?

— Raymond, Calif.

When I reached out to my friend Christopher Clarke with your question, he said, “That’s so cool that a kid is asking about inflation!” I agree.

Clarke is an economics professor at Washington State University. He told me inflation is the average rise in prices for goods and services.

So, what are goods and services? Let’s say you go to a restaurant and order enchiladas. The enchiladas are goods. You can see them, touch them and taste them. Services are the other parts of your dining experience. The people who take your order, cook your food and wash your dishes are all providing services.

The price you pay for goods and services changes over time.

“The November 2022 inflation rate actually just came out this morning,” Clarke said. “The number was 7.1%. That means if you take all the prices for your monthly budget — your groceries, your automobile, your gas, your rent for your house — and average that all out, prices grew by 7.1% over the past 12 months.”

How do we know that? In the United States, a government agency called the Bureau of Labor Statistics tracks prices. Then, they make a report called the Consumer Price Index. It shows how prices changed over time.

In the report, goods and services are grouped into categories, like food or recreation. So, you won’t find specific information about enchilada prices. But let’s say you tracked enchilada prices on your own. Your data shows that the average price for enchiladas was $4 last year. This year it’s $5. That means your enchiladas are 25% more expensive.

The Consumer Price Index does the same thing — only with more complicated math. Clarke told me that a 2% increase in prices every year is normal.

Clarke also told me that inflation has to do with supply and demand.

Supply is how available a good or service is. When something is rare or hard to find, people may pay more for it. Supply also affects the people who make or sell goods and services. If there’s a tortilla shortage, restaurants might need to pay more to get them. Since the restaurant needs to make money, they might increase the price you pay for enchiladas.

Demand is the price people are willing to pay for something. This depends on how much money people have. If you have tons of money, you probably don’t care how much those enchiladas cost. If lots of people want something and are willing to pay more for it, the price might go up.

Clarke told me that beliefs can also influence inflation. If we all believe the economy will chug along normally, we make choices and agreements (like work contracts or contracts to buy big things like houses) that reflect that. If something happens that makes us worry about the economy, we might make different choices and agreements.

You can learn a lot about economics and how inflation works by picking something and tracking its price all year. Do you see patterns in your data? Does the price change with the season or something else? Watch those patterns and trends over time to get a feel for economics in action.

Have a science question? Ask Dr. Wendy Sue Universe, WSU’s resident science cat and writer, by email at Dr.Universe@wsu.edu, on herwebsite at askDrUniverse.wsu.edu, via Twitter at @AskDrUniverse or at facebook.com/AskDrUniverse.