Deflation is when prices drop because machines make things cheaper, resulting in commoditization, fewer jobs, and lower income for most people.
In Donut Village, everyone makes donuts. They’re made lovingly by hand, and donut making supports many families, as it has for generations. It costs the villagers about fifty cents to make each donut (including ingredients and labor), which they sell for $1 each.
One day, someone invents a donut machine which can make thousands of good donuts per day automatically, at a cost of ten cents per donut. Suddenly good donuts are selling for a quarter of the price they were before, and most of the bakers in town are out of business. Then another person invents an even better donut machine, and starts selling good donuts for even less. You see where this is going.
Deflation has hit Donut Village, with the following effects:
– Most people in Donut Village lose their donut-making jobs, so have less income. Their labor has been ‘commoditized:’ instead of crafting and selling donuts directly, all they can get now is lower paying donut-delivery jobs.
– The Donut Villagers have less money to spend so can only afford cheaper goods. Now only really cheap products sell well in the village… causing inventors to try to invent even more machines, to make everything as cheap as possible.
– Donuts are now super cheap, so people are eating a lot more of them. So the owner of the donut machine can get an even better deal on raw ingredients, buying in greater volume and making even higher profits.
– The person who invented the best donut machine (and her investors) has gotten really rich. Income inequality in the village has grown… there are lots of people with less income than before, and a few people with a lot more income.
Deflation has conquered Donut Village.