Benefits and costs of inflation

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  • Created by: Jade
  • Created on: 08-01-13 12:46

Benefits and costs of inflation

Advantages

  • Low and stable demand pull - higher AD may encourage firms to increase output.
  • Gives firms the ability to alter workers real pay and can help labour markets operate more efficiently and reduce unemployment - keeping money wages the same or raising them less than inflation.

Disadvantages

  • Fall in value of money - each pound coin buys less - purchasing power decreases.
  • Menu costs - costs of changing prices due to inflation. e.g. new menus, catalouges.
  • Shoeleather costs - costs in terms of the extra time and effort involved in reducing money holdings - and seeking the highest rate of interest.
  • Administrative costs - staff time may be devoted to adjusting accounts, assessing raw material costs, estimating appropriate prices.
  • Fiscal drag - tax brackets not adjusted in line with inflation, people's income pushed into higher brackets - decreases their disposable income, increases gov tax revenue.
  • Loss of international competiveness - inflation - harmful effects on country's trade position if inflation rises higher than trading partners. Makes goods and services less price competitive - result in lower exports, higher imports

Evaluation

Depends upon - rate of inflation, whether it is fluctuating, whether it was correctly anticipated, its rate relative to that of other countries. Type of inflation - cost push is more harmful for an economy - cost push inflation - often accompanied by a fall in real GDP and a rise in unemployment.High rate of inflation more harmful. Unanticipated inflation causes uncertainty and can result in a random redistribution of income.

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