Professor Timothy Taylor begins this video lecture by defining inflation. He explains that the term "inflation" refers to the overall increase and decrease in the price of many goods, not the price fluctuation of just one individual product or service. He then explained the "basket of goods" concept, which is used to measure the rate of inflation over a period of time. This concept consists of choosing a "basket" that includes a particular set of goods, whose prices can be measured at a specific point in time. This amount is then compared to the price of that same basket of goods at a later time, in order to ascertain the rate of inflation over that period of time for those particular goods. There are various price indexes that measure the rate of inflation for different baskets of goods.

In order to measure inflation, a basket is picked and a price index is set up (meaning that the cost of a basket in one particular year is chosen). Thus the government chooses a "base year" and assigns the basket price for that year the number "100". The prices of that same basket for following years are then described in terms of the base year (i.e. 102, 105, etc. These are known as "index numbers").

The basket of goods method of measuring the rate of inflation has some flaws. When looking at a basket of goods over time, you cannot alter the items it includes. Thus an average basket of consumer goods from 1970 might differ in the type of its products than a consumer basket in 1990. This may mainly be due to the progression of technology and amenities available to consumers, couples with price fluctuations that encourage people to change their buying choices. These variables cause changes in consumption preferences, and hence the change in value of an average consumer basket may not be a result of inflation. In addition, new products such as cell phones and pharmaceutical technology are not incorporated quickly into the inflation rate or cost-of-living. The rate isn’t capturing new benefits resulting from new patterns of consumer behavior, new technology, etc. In this way, the official rate of inflation issued by the government may overstate the true values.

In truth, the essence of inflation is momentum and the fact that it feeds on itself. Once inflation gets an initial push, it is self-perpetuating. There are two kinds of inflation, cost-push inflation and demand-pull inflation. Cost-push inflation occurs when costs rise in one sector of the economy and push up the prices of other goods. Demand-pull inflation is when there is too much spending power in the economy, with too many dollars chasing too few goods. Inflation cycles between these two modes:

The pattern of inflation has a predictable trend – inflation invariably occurs right after a war because there is two much demand in the market. Inversely, when there is too little buying power for a surplus of goods deflation occurs, causing a depression such as the Great Depression of the 1930’s. Thus wars and depressions can cause demand-pull inflation and deflation, whereas cost-pull inflation can be the result of a price increase in an item such as oil.

The real question that economists try to answer is why is inflation sometimes built into the economy, and how do we break the cycle of expectations (the expectation of the people that at certain times, in certain situations, inflation will occur) to get it out? In order to elaborate on this question, Professor Taylor asked, "Why is inflation bad?" His "economist’s" answer included a scenario in which a magical elf drops from the sky and doubles all money. In is logical that when people wake up and discover this, they would immediately rush of to buy things. Stores see this sudden increase in demand, and decide to double their prices since everyone has twice as much money. At the end of the day, no one is really better off than before. The significance of this illustration is that the real meaning of the standard of living is not how much money someone has in their wallet, but rather how much they are able to consume. In this way, doubling all money did not have an impact on individual’s standard of living because nobody was able to consume more. Thus from an economist’s point of view, inflation is really just changing the price tags on things without actually altering the economy. However, from the "people’s" perspective, inflation can be a devastating phenomenon. In the real world, inflation is not simultaneous or equally distributed. Even is the overall average doesn’t seem to suffer, individuals can be faced with the inflation of an item that directly affects them with the countering affect of increased wages. If a person’s child is allergic to all materials except cotton, and suddenly the price of cotton skyrockets, then that particular family is financially in trouble because of inflation. The following chart is a general outline of who suffers and who benefits from such sudden shifts in inflation rates:

Who Loses:
1. Money Lenders	Get repaid with dollars that are worth less than when they were loaned
2. Cash Holders	Cash that is stashed in one’s mattress diminishes in value over time

Who Wins:
1. Money Borrowers	Government repays bonds, etc. in inflated dollars
2. People With Material Investments	Material investments such as houses are subject to inflation

Those who have suffered from inflation have called it a "monetary disease that causes money to disintegrate." Inflation encourages inward thinking, a.k.a. worrying about how inflation is affecting you. This in turn detracts from productivity, wasting time and energy. "Productivity is the secret to progress" and a healthy economy, and this perspective allows us to see yet again why it is so important to correct inflation.