effects of relatively high inflation rates (3)

Question 1

microeconomic impacts of relatively high inflation rates

Answer 1

1. reduced consumer purchasing power + real incomes -> high inflation (e.g. 10.1% in UK in 2022) -> prices of goods and services rise faster than wages -> real incomes fall -> decreased purchasing power -> affects those on fixed incomes (e.g. low-income workers, pensioners, etc) -> higher living costs -> less disposable income -> lower consumer spending -> demand for inferior goods may increase as consumers look for cheaper alternatives -> incr revenue for those businesses -> more SNP
2. uncertainty + decr business investment -> high inflation makes future costs unpredictable (e.g. raw materials, wages, etc.) -> businesses struggle to plan long-term investment -> less business confidence -> less non-price competitiveness -> cost push inflation would mean higher production costs -> lower profit margins -> discourages capital investment, expansion or hiring -> slower growth in productivity and employment -> unable to achieve dynamic efficiency

Question 2

evaluate microeconomic impacts of relatively high inflation rates

Answer 2

• depends on the inflation rate -> if mild (e.g. around 2-3%) -> this can encourage borrowing + investment since firms can anticipate rising prices and demand
• if demand is price inelastic -> state reason -> pass costs onto consumers -> protects profit margins
• if wages rise in line with inflation -> higher real income -> purchasing power does not fall significantly
• depends on whether the inflation is long-term

Question 3

macroeconomic impacts of relatively high inflation rates

Answer 3

• declining international competitiveness + worsened BOP -> if inflation is higher than that of trading partners -> higher domestic costs for UK businesses -> UK exports are more expensive -> less price-competitive in global markets -> less export revenue as foreign buyers switch to cheaper alternatives -> incr demand for cheaper imports by UK consumers -> worsens trade balance -> worsened current account deficit
• policy response -> higher interest rates + economic slowdown -> central bank (e.g. BoE) raise interest rates to control price hikes -> higher IR = incr COB + RFS -> lower spending + investment -> reduced AD -> mortgage repayments rise -> less disposable income for homeowners -> reduced living standards -> slowdown in economics growth -> incr risk of stagflation (high inflation + low growth)

Question 4

evaluate macroeconomic impacts of relatively high inflation rates

Answer 4

• depends on the PED of exports + imports -> if exports = price inelastic -> export revenue likely to rise if there’s an increase -> current account deficit may improve
• impact of exchange rates -> higher inflation may cause currency depreciation -> exports cheaper to foreigners -> more price-comeptitiveness
• effects may be cancelled out if other trading partners have higher inflation rates