Define inflation. Assume that you live in a simple economy in which only three g

Question

Define inflation. Assume that you live in a simple economy in
which only three goods are produced and traded: fish, fruit, and
meat. Suppose that on January 1, 2007, fish sold for $2.50 per
pound, meat was $3.00 per pound, and fruit was $1.50 per
pound. At the end of the year, you discover that the catch was
low and that fish prices had increased to $5.00 per pound, but
fruit prices stayed at $1.50 and meat prices had actually fallen to
$2.00. Can you say what happened to the overall price level/
How might you construct a measure of the change in the price
level? What additional information might you need to construct
your measure?

Explanation / Answer

Inflation is an overall rise in price levels determining what product is being discussed. In this case, fish prices have inflated that could involve multiple factors. One the demand for fish could exceed the supply making fish a valuable commodity. On the other hand meat prices have fallen showing a slight deflation in market for meat. This is opposite of what your seeing in fish prices. This is caused by supply surpassing the demand that the public needs. Hypothetically speaking (although this is a threat for future generations) oil reserves will deplete sometime in the future making the demand for gas extremely high, which will reflect in prices inflating.

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