The US dollar is not only a medium of exchange, but it is also a commodity that obeys the Law of Supply and Demand.  All money today is fiat money, which means it has no intrinsic value of its own, except perhaps to collectors on rare issues.  While governments are free to print money at will, they still obey the Law of Supply and Demand, which dictates that increasing the supply of currency in circulation, if not accompanied by a corresponding increase in demand, will lower the value of the currency.  The loss in value of a currency is inflation, reflected as a lower purchasing power for the currency, and seen as higher prices for goods and services. 

This is depicted in the chart below.  If the value of a dollar, P₁, is stable at the supply in circulation at Q₁, and the supply of dollars in circulation is suddenly increased to Q2, their will be a disturbance in the Supply curve from S1 to S2, which causes a decrease in value of the dollar to P₂.  This is supply-side economics that can lead to inflation -- too much of an increase in any commodity in the distribution chain causes its value to decrease.

If in addition, the demand side is manipulated, so that demand decreases (for example raising the price of gasoline, or or raising the price of labor, or raising interest rates on borrowed money) so that a reduction in demand occurs, that also can cause the value of the dollar to drop in value, from P2 to P3 in the chart.  This is demand side economics -- artificially raising prices on commodities causes their value to decrease.

Normally, manipulating a few commodities does not result in inflation, as substitutes can be employed.  But a few commodities, such as crude oil, have a large reach into the price of many commodities, which, if manipulated, can have inflationary consequences.

©2008, Simon Revere Mouer III
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