Inflation, Oil and the Environment

I recently received a great question from a 6th Grader on Inflation, Gas Prices and the environment all rolled into one. It isn’t often that 6th graders think about these issues so I would like to share my response with you…

To whom it may concern,

My name is Sam and I am a 6th grade student at (deleted) Middle School. I love traveling. Whenever I go places I see lots and lots of poverty. I think to myself why? Than I look ahead of me and see the outrage sky high prices for food, gas and many other things.

You may be wondering why I’m telling you this .I’m doing a project on one of the things that you know a ton about. My subject is inflation of consumer and gas prices. As I think about the fact that gas is so expensive. I also think about why.

Than I remember that they are destroying habitats for animals. As the thoughts run through my head I wonder how can I stop this. This is my whole point of my project. I also realize that the demand for gas is very high. But the bigger demand the more wildlife is cut down and the higher the prices go. If this cycle keeps going on than the some people wont be able to offered to heat there homes or drive too work or even feed there family. Please send me as much information as you can so I can complete my project.

Thank you,

Sam

Dear Sam,

Thank you for the well thought out letter. It is good that you are thinking about inflation, Oil prices and the environment. Unfortunately it is a very complex subject so I will start with inflation.

Inflation is not caused by prices going up or greedy businessmen wanting more money or destroying the environment. It is caused by the Government printing more money. When the Government increases the money supply each dollar is worth less.

Here is an example: Suppose you had ten people on an island where each person has $1. and each person had one item for sale. The average price for each item would be $1.

Now suppose you wanted to make everyone richer so you gave each one another dollar. There are still only 10 items for sale but now there is $20 to spend so the average price would now be $2  This means the price doubled, so no one is any richer because they can still only buy one item with their $2.

But suppose instead of being given another dollar each of those people worked and made another item to sell instead. Now there are 20 items and only $10 to buy them. At first it looks like everyone is poorer but really the average price will now be 50 cents each, so everyone can afford two items.

Even though we call rising prices “inflation” it is actually not the cause of the problem it is simply the result of the Government printing more dollars.

The other way you can get increasing prices is to decrease the supply. If half the items on our island washed out to sea there would only be 5 items left. But there would still be $10 to buy them. So once again the average price would be $2. So inflation can result from more dollars or less products (goods).

So far we have talked about the supply of goods and the supply of money. As you mentioned the other side of the issue is the demand for goods. If more people want the same thing and there is a limited supply they will pay more to try to get it away from the other people.

Now on to the price of Oil

Oil is like everything else, its price is a result of supply and demand. Recently demand has increased (because people in China are getting richer- not poorer- so they are able to afford cars now. So of course they want gas for their cars) at the same time we had a big hurricane that knocked out some of the supply. So we had supply going down and demand going up. This means that people are willing to pay more because they want it more.

If you look at the chart below you will see what happens when we adjust the price of gas for the increase in the number of dollars that the government printed. The red line is the adjusted price of Gas. You can see that gas is actually cheaper now than it was in 1918 when the chart started.

Environmental Issues and the Price of Gas

None of this has anything to do with the environment. The only thing the environment has to do with the price of Gas is that some people want to stop oil companies from drilling new wells to protect the environment. This reduces the supply of oil and causes it to be more expensive. Most people don’t realize the costs involved in protecting the environment.

Have you ever heard the saying “you can’t have your cake and eat it too”?  Every choice you make has trade-offs. You can choose to have cheaper gas or protect the environment but you can’t have both. Which would you choose?

But as gas prices go up people start to conserve gas. They buy smaller cars, stop driving SUVs, and car pool etc. This can help reduce the demand for gas so the price can go back down some.

Hope This Helps,

Tim McMahon, Editor
InflationData.com
“The Place in Cyberspace for Inflation Information”

Oil is like everything else, its price is a result of supply and demand. Recently demand has increased …

 

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