cost and benefits of inflation

Question 1

what are the 6 costs of inflation

Answer 1

lower purchasing power
erosion of savings - shoe leather costs
lower export competitiveness
wage/consumer price spirals - menu costs
fiscal drag
inflationary noise

Question 2

what are the 6 benefits of inflatino (if low and stable)

Answer 2

wokrers can bargain for higher wages

consumption is natural

firms are encouraged to increase output

can keep unemployent low in a recession

reduces real value of debt

imporvemtn of gov finance

Question 3

explain lower purchasing power

Answer 3

for hh and workers

assumign wages and incoem s not increasing in line with inflation

in rela terms workers worse off

this can affect ability to buy basic goods and sercice

can affect sol

for those on low incomes can drive em into poverty and deprivation

Question 4

explain erosion of savings

Answer 4

assuming the interet rate is not in line with tinflation

if ir is less than inflation in real terms saving is loosing value

bad for thosee relying on savings suhc as unemployent , economically inacrive , old age pensioners

this can decrease DOL

those saving to buy house - means its harder to reach financial goals

Question 5

explain low export competitiveness

Answer 5

if interst rate icease in a country faster rekative to others

exports decrease demand this decreases export rev (LOD)

worsens current accoun position

decreases x -m

lowers AD

lowers econ growth

Question 6

who is low export growht especially bad for

Answer 6

cunch who are trade dominant and rely on exports for ecnomic growth

exports are more conc in africa which is a developing econ

Question 7

explain wage spiral

Answer 7

occurs when risk of increasing inflation becomes anticipated then spirallig potentially creating hyper inflation

leads to moreinflation , workers anticipate inflation then bargain for higer wages because they wana keep up with the cost of libing

ask for at least inflation equalling pay rise

if firms fo this they increase COP, pass this on thorugh higher prices

this increases inflation

means worekrs ask for ahigher pay rise

leads to inflatino sprial

• can this be heightened by trade unions andpeople all comign together asking for higher pay rise

Question 8

explain consumer spiral

Answer 8

if consuemrs anticipating high inflation rational thing to do

bring forward consumtion, even if dont needs goods rn

dont wait as 3 will be hgher

rational consumers protect themselves from what they think will eb higher infaltion
if all consumers act rationally and bring forward consumption

this increases AD and DPI

Question 9

EXPLAIN menu costs nd high inflation

Answer 9

inflation is high and rising firms continue to print new menu prices and catalogues

to keep updaitng = costly

pass onto cosnuemrs via higher prices

leads to inflation

Question 10

f we end up with hyperinflatino hwats a nice link we can make

Answer 10

it can ruin eocn and intensify other costs of inflation

Question 11

explain fiscal drag cost

Answer 11

inflation rising means workers recieiving hihger incomes

but only in line with inflation

in real terms not better ooff as pay just rising in line with col

but if pay rises means in a progressive tax system theyre worse off as get dragged into hgier tax bands

they pay more tax whihc increases SOL

Question 12

Why is a fiscla drag good for the gov

Answer 12

they recieve a tax rev windfall

Question 13

describe what type of cost fiscal drag is

Answer 13

subtle unrealised cot of inflation

Question 14

how do we evaluate fiscal drag

Answer 14

we make assumtion of progressive tax systme being used - not case in lithuania

assume tax bands arent rising in line with inflation

Question 15

explain inflationary noise

Answer 15

when IR is volatile

price signalling funcitno of mkt completley looses its value and significance

so with volatile inflation people start to loose understndding of whats happenig w price

this creates uncertianty in econn

casuog consmers to put off C

firms to put off I plans

this can hold back eocn growht as AD shift left as cmoponent vlaues reduce

Question 16

explain workers can bargain with ghier wages beenfit

Answer 16

even if all they get is inflation = pay rise
dont matter

workere liek hgiher wages

its good for moral and productivity

an shift LRAS right as quality of labour has increased

increases ouptut increases econ growh

Question 17

explain consumtion is natural benefit of inflation

Answer 17

with a low and stable inflatino rate

consuemr wont bring forward or delay soednng

which is the case why high inflaiton and defation - non are anticipated

they buy g/s when they need to

consumption is fluid whihc is good for econ groht as wont get shocks which can plunge econ into a recessio

Question 18

explain firms encourage dto increase otuptu

Answer 18

if low an dstavle

firms know they can icnrease prices and earn more revenue so chance to make more ouotu and sell at a higher price and earn mroe

Question 19

expain low and stable inflationc an keep unmployment mlow ina recession

Answer 19

ina recessionnormal for firms to sack workes as rev is falling so good way to keep costs under control
and decent profit margins

firms dont want to do this as hard to have skilleed productive wokers + all traing that been put in n , if get rid of them , hard to get them back again

so if some inflaiton frims can keep workers

CAUSE FIRMS CAN ICNREASE COSTS BY INFLAITON BUT ONLY INCREASE incomes by by 1% - still increaseing rev

this means they can still keep workers in place

goood for firm as keep productive wf/ decent prof margins

good for wokers as keep work in a rcession

good news for gov as key macro obj of unemp dont get out of ctrl

Question 20

explain +ve of inflaiton reduces real value of debt

Answer 20

workers can bargainfor higher wages during low and stable inflarion so have more income

forms can mke more profits when higher inflation

so wages, profit and rev tend to rise so easier to service debt

debt is fixed vlaue so easier to service - which is +Ve - why

Question 21

explain +ve of improvemen of gov finances

Answer 21

get fiscal winfall when inflation

as wokrers earning more

meaning dragged into highe rtax bands so gov beenfts

+ taxes absed on nominal value of g/s e.g vat as prices rise gov collects more rev e.g fuel duyt

+ gov is not spending as much on public services in rela terms there is a fall in funding publi services i real terms as a fall in public sector wages

this decreases the real value of their national debt

Question 22

explain +ve of firms encouraged to increas otput

Answer 22

if low and stable they now they can increae £ and earn more revevnue do chnce to make mroe ouputu and sell at a highe rprice so they earn more

Question 23

wha are the 5 evaluation pints

Answer 23

rate

cause

duration

anticipate/unancticipated

stablity of rate of infaltion

Question 24

explain eval point rate of inflation

Answer 24

fi its low and stable = mor benefits than csts

higher rate of inflation = costs are significant and we have the risk of spirals

Question 25

explain eval of cuase

Answer 25

dpi more favourable as we get more groth and lower unemp

cost push inflatino = lower growht and more unemployment which can result in stagfaltion concerns

dpi easier to solve than cost psuh - we can use deamnd side inflaitnory policies
if cost push gets out of ctrl a lot of the time nothing you can do

Question 26

explain eval duration of inflation

Answer 26

long term high rates of inflation can become anticipated which can lead to spirals casuing higher inflation

Question 27

explain anticipate/unanticipated eval

Answer 27

anticipated is bad whic ofte comes if infaltion is high and lt in nature - so risking spirals

unancticipted is not ba

Question 28

explain stability or rate of inflation

Answer 28

if its volatile more inflationary noise which harms consumtion and investment in eocn