Lets try to understand inflation by looking at the prices of 1 thing.

I pick Rice, because a huge number of people consume it everyday, especially myself, and the quantity I consume doesn’t change much with each day, therefore, it can be reasoned that rice demand per person doesn’t change too much over a year.

Okay, time for some Maths. Bear with me here, it gets really interesting.

Rice consumed in India: 81.7 million tonnes (2001) -> 95.287 million tonnes (2011) [1]

Population of India: 1028 million (2001) -> 1210 million (2011) [2]

Therefore, Rice consumed per person (in a year): 79.4 kg (2001) -> 78.7 kg (2011)

Slightly less rice per person, but still, not much of a real difference. So, the supply of rice per person is roughly the same, and the demand for rice didn’t change too much either, it stands to reason that the price should be similar. I mean, why would everyone be willing to pay more for the rice, when no one needed any more?

Wrong, my smart, but naive reader.

Price of rice: ₹8.6 per kg (Jan 2001) to ₹30.8 per kg (Dec 2011) [3]

That’s a tripling of price over a period where we had the same amount of rice every year. What’s up with that?

We need some out-of-the-box thinking here. The demand and supply of rice didn’t change, but what about the other side of the transaction, the Rupee?

Think about it, each transaction is a trade: a trade between Rupees and kilos of rice. So, on average, if there are a total of x Rupees in India and y kilos of rice, the price of rice should be x/y (total rupees/ total rice). Now, the price, ie, the ratio x/y has increased. Only 2 reasons for this to happen. Either y decreased (which the above shows is unlikely), or x (number of rupees) increased.

Conclusion: the increase in the total number of Rupees in India caused the increase in price of rice. Huh, look at that, inflation isn’t divine law after all, just an increase in the total number of Rupee notes and coins.

So what, you might be thinking, if the Rupee supply doubles, the price of everything doubles, including my salary. My situation hasn’t changed, right?

Let’s look at an example to illustrate that.