I'll try to keep this as brief and visually-oriented as possible.
First, what is MUDflation?
Well, as you may have noticed, it's a portmanteau made up of the words "inflation" and "MUD" (which, in its turn, stands for Multi-User Dungeon, which we can basically file as a precursor to MMOs). The word was first coined to refer to actual monetary inflation that happened in Everquest. As time passed in EQ, platinum became less valuable, so it took more of it to buy items. This in many ways mirrored real-life inflation, but it got its own name: MUDflation.
In more recent years MUDflation has also come to refer to item stats -- rather than gold -- in MMOs running out of control. I believe this is best illustrated with actual items, so bear with me for a second with a reference to WoW.
Here is a standard level 60 2 hander:
Here is a standard level 70 2 hander:
Here is a good (but not best in slot) level 80 2 hander:
Here is a pending level 85 2 hander:
Even if we're going by DPS alone, the advances are staggering.
What's worse is that this is true of all gear
in WoW (not just weapons): with each expansion, stats have mushroomed almost uncontrollably, and the result is that a level 85 epic is now doing 100x the damage of a level 60 epic.
"But Shrike, what does it matter?"
The problem with MUDflation is twofold:
1) First, it upsets stable progression and itemization.
In vanilla WoW, items that moved up 1 or 2 DPS over their predecessors were considered very good. Thus, if you were wielding a dagger that did 45 DPS, a 47 DPS dagger was much, much better. This had a distinct side bonus, however: it kept "bad" gear from ever really being too bad.
Thus, even at the end of vanilla, blue items -- while certainly not cherished -- were still considered good.
Up to the very last day before Burning Crusade launched, people were still running Stratholme and Scholomance and Upper Blackrock Spire (for those of you who didn't play WoW, they're non-raid instances [except BRS, which was small raid]) for blue (not epic) gear. The stat bumps weren't so significant that they completely illegitimized earlier gear, and as a result, players who weren't at the cutting edge of gear were still able to hold their own.
Ergo, Jimmy in his blues, might still have a hope of beating out Tom in purples if Tom sucked -- be it in PvP or PvE. None of this is true in WoW anymore.
2) Second, and more importantly, MUDflation is breaking instance progression in WoW.
In vanilla, up until the last few weeks, people still ran Molten Core and Onyxia (entry level raids), if not for their mains -- though some guilds were still on this content for their mains -- then for their alts. The gear was still considered good (if not great), and a full set, even of Tier 1, was something to be proud of. Flash forward 4 years to today. Of the 4 major endgame raid instances (Nax Redux, Ulda, TOC and Icecrown), the only two instances that progressed servers run are Icecrown and TOC hardmode (and the latter is becoming increasingly rare).
Because the stat leaps from set to set in modern WoW are so enormous that gear from old instances -- even one instance behind the present "cutting edge raid" -- is considered massively outdated.
Let's look at two items as an example.
Here's an epic 2 handed sword from modern Onyxia (one item level leap behind current raid progression):
Now here's the more modern Bryntroll again:
Of course, that's the non-heroic Brytroll -- this is the better version of the weapon:
And, if you're curious, here's the best-in-slot item:
And this isn't just bad because it suddenly gimps every piece of gear that you got out of the preceeding instance. No, it's bad because raid dungeons are incredibly complicated and expensive to design, and thus -- if MUDflation reduces their usefulness from the length of an expansion to the length of a patch -- the money and effort involved in their creation is debased as a result. In a nutshell, in-game inflation causes real-life deflation.
Here's an image I whipped up for the discussion on page 22 of what happened in WoW, and what an ideal MMO should look like. The blue line is essentially the strength of players based on their stats and that of their gear:
In essense, WoW now has 1/4th of the content it might have had during this expansion, while simultaneously destroying the usefulness of entry-level gear, and
ruining the chances of Jimmy to beat Tom no matter how unskilled Tom is. If Tom's wielding: http://db.mmo-champion.com/i/49623
... Jimmy doesn't have a chance in hell with his: http://db.mmo-champion.com/i/45205
That's the terror of MUDflation. It must be avoided at all