The Consequences of Inflation

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    The Consequences of Inflation

    Fall in the Value of Money

    • Whether a household’s purchasing power actually decreases, however, depends on whether their income rises above the rate of inflation

    Menu Costs

    • These are the costs of changing prices due to inflation

    Shoeleather Costs

    • During times of high inflation, if money’s lying around, it’s losing value
    • Time and effort therefore has to be taken in finding out where the money can gain the most interest in terms of which financial institutions/banks to put it in
      • This time and effort is seen as a ‘cost’

    Administrative Costs

    • Things like negotiating new wage rates of adjusting accounts take time and effort

    Inflationary Noise

    • This is the distortion of price signals by inflation
      • g. if the price of a TV rises, it would be hard to tell if it’s a relative price rise or it’s just a price rise that’s in line with inflation

    Fiscal Drag

    • This would occur when people’s income is dragged into higher tax bands due to tax brackets not changing in line with inflation

    Uncertainty

    • If firms are uncertain about what costs will be and what revenue they can take, they may be reluctant to invest
    • Likewise, uncertainty also means that households will find it difficult to decide how much and when to save.

    Inflation Causing Inflation

    • If consumers think that prices are going to rise in the future, then they’ll spend more in the present, which will then increase AD

    Loss of International Competitiveness

    • If the rate of inflation in a country is higher than its competitors, its goods and services will be less price competitive
    • This is likely to result in fewer exports sold and more imports being purchased.

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