There is a small island far far out in the ocean. On the island are two villages, Unbrellina and Chairica. Unbrellina was so-named because it is home to renowned maker of beach umbrellas, Joseph Umbrellaman. Chairica was named for Samuel Chairman, whose business of making quality beach chairs is legendary in oceanic lore.
Both Unbrellina and Chairica use the same currency, the Nemodollar.
Unbrellaman sells his umbrellas for $10, both locally and for export to Chairica.
Chairman sells his chairs for $10, both locally and for export to Umbrellina.
Chairica has a local manufacturer of umbrellas, Sydney’s Umbrellas, but since Sydney’s is not efficient, its price for umbrellas is $15. Value-minded Chairicans therefore buy most of their beach umbrellas from Umbrellina.
Similarly, Umbrellina has a local manufacturer of beach chairs, but because of a shortage of chair-stuff he has to price his chairs at $15. Consequently, Umbrellinians buy most of their chairs from Chairica.
One day, the Chief of Chairica, in order to help his friend Sydney, slaps a 100% tax (a.k.a. tariff) on umbrellas from Umbrellina. Umbrellas from Umbrellina now cost Chairicans $20 instead of $10. Naturally, value-minded Chairicans stop buying imported umbrellas and begin buying $15 umbrellas from Sydney.
The Chief of Umbrellina is not happy with the new tariff on his main export. He retaliates tit-for-tat. He slaps a 100% tax on chairs from Chairica, imported chairs now costing $20. Value-minded Umbrellinians stop buying imported chairs, and begin buying $15 locally-made chairs.
Who wins and who loses from these events?
Sydney of Chairica is happy because his umbrella business is more profitable. The two additional employees he hires are happy to be employed.
Umbrellica’s local supplier of chairs is happy because of increased sales of his chairs. The two additional employees he hires are happy to be employed.
But the 1000 consumers in Chairica must pay 50% more for every umbrella they buy. And the 1000 consumers of Umbrellica must pay 50% more for every chair they buy.
The consumers of both villages lose. It’s called “inflation.”