Effects of Inflation
The effects of inflation will depend partly on whether it is ‘anticipated’ or ‘unanticipated’ inflation. The Impact also depends on the levels of inflation; high levels are more damaging than low levels. Inflation can cause a number of problem for an economy, such as the following:
• If prices are increasing this creates costs for firms because they may have to update menus, price lists, brochures, and other materials when prices change in an economy to reflect the higher prices. Because this transaction cost exists, firms sometimes do not change their prices when the economy puts pressure on it, leading to price stickiness. Generally, the effect on the firm of small shifts in price (by changes in supply and/or demand, or else because of slight adjustments in monetary policy) are relatively minor compared to the costs of notifying the public of this new information. Therefore, the firm would rather exist in slight disequilibrium than incur the menu costs. These are called ‘menu costs’.
• With higher rates of inflation, individuals and firms may have to search more to find the best returns on their savings such as holding less cash and having to make additional trips to the bank. The costs of searching around are called ‘shoe leather costs’ which refer to the cost of time and effort (more specifically the opportunity cost of time and energy) that people spend trying to counter-act the effects of inflation.
• Not all individuals will have the bargaining power to ensure that their own earnings rise at the same rate as prices are increasing. If your income doesn't increase at the same rate as inflation, you will find your standard of living declining even though you are making more. Also, inflation doesn't impact everything equally, so that some things (such as gas prices) can double while other things (home) may lose value. For this reason, it makes financial planning more difficult. Real income has fallen. The ability of an employee to bargain for higher
• If prices are increasing this creates costs for firms because they may have to update menus, price lists, brochures, and other materials when prices change in an economy to reflect the higher prices. Because this transaction cost exists, firms sometimes do not change their prices when the economy puts pressure on it, leading to price stickiness. Generally, the effect on the firm of small shifts in price (by changes in supply and/or demand, or else because of slight adjustments in monetary policy) are relatively minor compared to the costs of notifying the public of this new information. Therefore, the firm would rather exist in slight disequilibrium than incur the menu costs. These are called ‘menu costs’.
• With higher rates of inflation, individuals and firms may have to search more to find the best returns on their savings such as holding less cash and having to make additional trips to the bank. The costs of searching around are called ‘shoe leather costs’ which refer to the cost of time and effort (more specifically the opportunity cost of time and energy) that people spend trying to counter-act the effects of inflation.
• Not all individuals will have the bargaining power to ensure that their own earnings rise at the same rate as prices are increasing. If your income doesn't increase at the same rate as inflation, you will find your standard of living declining even though you are making more. Also, inflation doesn't impact everything equally, so that some things (such as gas prices) can double while other things (home) may lose value. For this reason, it makes financial planning more difficult. Real income has fallen. The ability of an employee to bargain for higher