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Inflation for Kids

November 22, 2009

There´s a lot to write about inflation but only a slice will be covered here. The goal is to show, by example, how the government uses inflation to increase Socialism. The example also shows how the public is deceived into blaming Capitalism for higher prices and the ensuing economic problems. The example, in this case, is a slightly modified version of one provided in “Capitalism” by George Reisman.

 

Many people experience inflation, and even define it, as a general economy wide rise in the prices of goods and services. While rising prices are only a symptom of inflation, not inflation itself, the example will focus on the symptom to make a few points.

 

Let´s say you´re in the pharmaceutical business making and selling a heart drug and on January 1st you buy $100 worth of chemicals to make the pills. To keep things VERY simple, let´s say the chemicals are your only cost and on December 31st of that year you sell all your heart drug pills for $110. That means there´s $10 gross profit for your business, from which you pay $5 in income taxes to the government, leaving $5 net profit. There´s also $100 left to buy chemicals to make next year´s supply of heart drug pills. If there is no inflation, you can operate your business year after year. Now let´s run through that example again, but this time with inflation. Here´s how it goes.

 

After you buy your $100 worth of chemicals on January 1st, let´s say the government creates 10% inflation. Simply put, they do this by working with the Federal Reserve to increase the money supply. Money is created out of thin air for Socialist programs. On December 31st you now sell your heart drug pills for $121 instead of $110. Since there´s $21 in gross profit, the government will want $10.50 in taxes leaving $10.50 net profit for your pharmaceutical company.

 

HOLY COW! Now the news media swings into action, proclaiming you´re gouging the public, doubling your gross profit to over 20% and your net profit to over 10% in one year. You´re the villain and the government is called in to do something about your unbridled greed. Let´s finish the math to see what a travesty this is and how the general public is deceived.

 

If you want to continue your business in the following year, the cost of your chemicals on January 1st is not $100 but $110 due to inflation in the price of chemicals. If you subtract this from your revenue of $121, you´re left with $11. The government takes $10.50 in taxes leaving your company with 50 cents in net profit!

 

That´s right, the government created inflation and the government took the bulk of the money through increased taxes ($5 in year the first year and $10.50 in the second year). The government now has even more money for its Socialist programs and private industry has that much less. Finally, along the way, the media views you as the greedy Capitalist, the people will call upon government to regulate your business and the market will become less free.

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