Gary Rabbior is the president of the Canadian Foundation for Economic Education. This is the third of a six-part series on understanding how the economy works and why it matters to investors.
In the last article, How inflation works, we used our Auction Block game to show that if we increase the amount of money in an economy, without producing more goods and services to buy, we get inflation. Now let’s use our Auction Block game analogy to make another point.
Suppose in Room #3 we have another game where we double the quantity of money again over that used in Room #1. But this time, we won’t double the players’ money equally. In Room #1 each of three players had $10,000 and there was $30,000 in the game. In Room #2 each of three players had $20,000 and there was $60,000 in the game. Now, we give one player $20,000, one player $10,000, and one player $30,000. The quantity of money in the game has doubled from that in Room #1 (i.e., from $30,000 to $60,000), but each player now has a different amount of money.
As with the game in Room #2, as this game begins the amount the players are generally willing to bid will likely rise above the prices bid in the game in Room #1. Why – because in this game, two players have considerably more money to spend ($20,000 and $30,000 rather than $10,000).
Once again, though, with no additional things to buy, this added spending will only serve to generate higher prices. However, as prices rise in this game we can see that players will be affected differently. If prices double in this game, the player with $30,000 will end up better off than if he/she was playing in the game in Room #1 because that player’s income has more than doubled. This player will find it easier to pay the higher prices in Room #3.
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