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  Effects of Inflation - Homework Help

Effects of Inflation

a) Larger Production and Investment

• (If inflation is not caused due to an increase in costs, i.e. cost-push inflation, then costs will always lag behind price increases...)

• As cost always lag behind price increase, this results in larger profit margins which not only stimulate production but also make more funds available for investment.

b) Distribution of Income  

• Inflation will result in some groups to gain at the expense of others.

• Fixed income earners (e.g. employees) will lose while variable income earners (e.g. businessmen) will gain.

c) Standard of Living

• If income of the individuals remains unchanged, any increase in prices will result in an increase in the cost of living and hence a lower standard of living.

d) Balance of Payments

• Domestic inflation will make domestic goods (i.e. our exports) to become relatively more expensive while foreign goods (i.e. imports) to become relatively cheaper.

• This may cause value of export to fall and value of import to rise and a consequent Balance of Payments deficit.

e) External Value of the Currency 

• With persistent price increase, the internal value of the currency (which means the purchasing power) will fall and this will lead to a fall in the external value as we require more of our currency in exchange for foreign currency.

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