Natural Direction of Prices

Feel it alright
It's the same with me too
There's something that's taken a hold of us
All that we say and we do
--Roger Daltrey

Suppose that all money to be used for exchange is created before economic activity begins. Furthermore, suppose that this money is completely durable and never wears out. Suppose that the total amount of money created is $10,000.

Economic activity begins. People engage in production and trade. In the first year, total output is 1,000 units. On average, the price of each unit of output is $10,000 / 1,000 = $10 per unit.

In the second year, productivity (defined as the amount of output produced per unit of input) improves 3% (not too far from the long term average annual change in productivity reported by the BLS). Total output in year 2 is 1,030 units. Average price per unit falls to $10,000 / 1,030 = $9.71 per unit.

In the third year, productivity improves 3% again. Total output increases to 1061 and average price per unit falls to $10,000 / 1,061 = $9.43.

If productivity improves 3% in year 4, then average price falls to $9.15 per unit of output.

It should be increasingly clear that in an economy with fixed money supply and improving productivity, the natural direction of prices is lower.

Yet, we have been conditioned to believe the opposite--that the natural direction of prices is higher.

But average prices can only rise when money creation outpaces production, or when productivity is falling. Neither of these conditions are "natural" and are unlikely to occur in an unhampered economy.

Make sure you understand what is going on here.