20.

8 The consequence of inflation

Disadvantage

Points Explanation Example

Reduction in net Cause the international competitiveness of

export a country’s products and increase import
expenditure and lower export revenue
Unplanned 1 some people may gain or lose as results
redistribution of of inflation. Borrowers will pay back less in
income real terms and lenders will receive less.
Savings makes income and savings less
valuable
Menu costs Costs involved in changing price. Affect
firms. Changing price involves staff time.
Discouragement of Unanticipated inflation can create
investment uncertainty and make it difficult for firms
to plan. This might dissuade firms from
investing, which will have adverse effect on
economic growth.
Inflationary noise Arises when inflation causes consumers
(money illusion) and firms to confuse price signals. Can
result in consumers and firms making the
wrong decision.
Inflation cause Inflation will cause consumers, workers
inflation and firms to expect prices to rise. Thus,
they may act in way that will cause
inflation
If the rate of interest does not rise in line
with inflation, borrowers will gain ad
lenders will lose. Savers will also lose out
as the rea value of their savings will fall.
Changing new catalogues, price tags, bar
codes and advertisement.
Firms seeing the price of their products
rising may increase output when the
higher price is the result of inflation
rather than increased demand for their
products.
Workers may call for higher wages, firms
may raise prices to cover expected higher
costs and consumers may seek to
purchase products now before prices rise
further.
Advantage of inflation

Points Explanation Example

Stimulates Low and stable inflation rate caused by increasing
output demand will make firms optimistic about the future. If
prices rise by more than costs, profits will increase, will
provide funds for investment.
Reduce burden Real interest rates may fall due to inflation. This is Those who have
of debt because, money interest rates do not tend to rise line borrowed money to
with inflation. Borrowers usually benefit from inflation, buy a house may
especially if it resembles an increase in income. experience a fall in
Individuals who take out a loan before inflation and a their mortgage
wage increase often benefit by having more money to payments in rea
pay off their debts. Financial institutions also have more terms
money as customers increase deposits. This makes
borrowing from banks easier.
Prevents some With an increase in the price of goods and services,
unemploymen companies typically see a growth in their revenue. This
t increase in income may offer them more capital to
expand their operations and increase their workforce. To
improve their production capacity and meet demands,
companies typically require more labor, which reduces
unemployment.
Wage When the cost of goods goes up, consumers tend to
adjustment push their employers for higher wages. To remain
competitive, employers must continually offer
higher wages. Thus, business will have a built-in
incentive to only hire productive workers since
they’re paying a higher wage. This allows businesses
to trim those who are underperforming and replace
them with better employees.

Factors affecting the consequences of inflation

The cause of inflation
The rate of inflation
The stability of rate of
inflation
Demand-pull inflation is likely to be less harmful than cost-push
inflation. This is because demand pull inflation is associated with
rising output whereas cost0pull inflation is associated with falling
output.
A higher rate of inflation is likely to cause more damage than a low
rate especially if the high rate develops into hyperinflation.
An accelerating or fluctuating inflation rate will cause uncertainty
and may discourage firms from investing.