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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