2.3.9

Consequences of Inflation

Test yourself on Consequences of Inflation

Test your knowledge with free interactive questions on Seneca — used by over 10 million students.

Consequences of Inflation

The consequences of inflation can have varied impacts on households, firms and the wider economy. These can be more severe if the inflation is unexpected and if firms, for example, haven't had a chance to plan.

Consequences for consumers

Consequences for consumers

  • For individuals, inflation will erode the real value of money. That is to say, real incomes will fall, as the purchasing power of incomes falls. So standard of living also falls.
  • Inequality rises because the more skilled workers can negotiate nominal wage increases that keep pace or outstrip inflation.
  • Cash loses value more quickly. This means that some consumers take more trips to the bank ('shoe leather' costs).
  • Menu costs are the costs firms face of keeping prices updated in shops.
Impact on savers and borrowers

Impact on savers and borrowers

  • Savers lose out because the real interest rate (nominal interest rate minus inflation) falls as inflation rises.
  • Borrowers gain because the real interest rate falls.
  • Indebtedness falls because the real value of debt falls as inflation erodes the real value of repayments.
Consequences for firms

Consequences for firms

  • Business uncertainty – volatile prices means firms may reduce investment because it is riskier.
  • Falling international competitiveness – a high inflation rate vs main trading partners will mean a country's exports will be less internationally competitive.

Consequences of Inflation (Cont.)

The consequences of inflation can have varied impacts on households, firms and the wider economy. These can be more severe if the inflation is unexpected and if firms, for example, haven't had a chance to plan.

The role of expectations

The role of expectations

  • If inflation expectations rise, this can cause people to spend now to avoid the future higher prices.
  • This could lead to demand rising, causing prices to rise even further.
  • Expectations of higher inflation could cause higher inflation: a self-fulfilling prophecy!
Wage-price spiral

Wage-price spiral

  • As inflation rises, people start to expect higher inflation.
  • This leads to them asking for higher nominal wage rises to keep pace with the rising cost of goods in shops.
  • Firms may grant this to begin with, but then as their costs are also rising, they may have to pass this on to consumers with higher prices. So they demand higher wages again.
  • This can become a vicious spiral.
Other factors

Other factors

  • The consequences of inflation depends on a number of factors:
    • Is it unexpected or expected ?
    • Is it a temporary or persistent problem?
    • The extent to which workers have negotiation power in terms of unions or skill level.
    • What is happening to nominal interest rates via the central bank response?
    • What is happening to inflation rates in the rest of the world?
Jump to other topics
1

Microeconomics

1.1

Competitive Markets: Demand & Suply

1.1.1Markets & Demand1.1.2Diminishing Marginal Returns1.1.3Supply1.1.4Market Equilibrium1.1.5Price Mechanism1.1.6Consumer & Producer Surplus1.1.7IB Multiple Choice - Demand1.1.8IB Multiple Choice - Supply
1.2

Elasticity

1.2.1Elasticities of Demand1.2.2Factors Affecting Price Elasticity of Demand1.2.3Elasticity of Supply1.2.4Price Elasticity of Supply1.2.5IB Multiple Choice - Price Elasticity of Demand1.2.6IB Multiple Choice - Price Elasticity of Supply1.2.7IB Multiple Choice - Other Elasticities
1.3

Government Intervention

1.3.1Indirect Taxes & Subsidies1.3.2Application Question - Taxing Prices or Quantities1.3.3Subsidies & Price Controls1.3.4Deadweight Loss & Government Intervention1.3.5Elasticity & Tax Incidence1.3.6IB Multiple Choice - Government Intervention
1.4

Market Failure

1.4.1Types of Market Failure1.4.2Introduction to Externalities1.4.3Negative Externalities1.4.4Policy for Negative Externalities1.4.5Positive Externalities1.4.6The Deadweight Welfare Loss of Externalities1.4.7Case Study - The Externalities of Education1.4.8Public Goods & the Free-Rider Problem1.4.9Asymmetric Information1.4.10End of Topic Test - Market Failure1.4.11Application Questions - Market Failure
1.5

HL: Theory of the Firm & Market Structures

1.5.1Theory of the Firm & Market Structures
2

Macroeconomics

2.1

The Level of Overall Economic Activity

2.1.1The Circular Flow of Income2.1.2Defining GDP2.1.3Limitations of GDP2.1.4IB Multiple Choice - Economic Indicators2.1.5Business Cycles2.1.6Output Gaps
2.2

Aggregate Demand & Aggregate Supply

2.2.1The Aggregate Demand Curve2.2.2Components of Aggregate Demand2.2.3Shape of the Aggregate Demand Curve2.2.4Shifts in Aggregate Demand2.2.5IB Multiple Choice - Aggregate Demand2.2.6Short & Long-Run Aggregate Supply2.2.7Alternative Models of LRAS2.2.8Equilibrium in the AD-AS Model2.2.9Output Gaps & the AD-AS Model
2.3

Macroeconomic Objectives

2.3.1Introduction to Unemployment2.3.2Limitations of Unemployment2.3.3Types of Unemployment2.3.4Causes & Impact of Unemployment2.3.5Defining Inflation2.3.6Measuring Inflation2.3.7Use of Index Numbers2.3.8The Consumer Price Index2.3.9Consequences of Inflation2.3.10Causes of Inflation2.3.11Inflation & Unemployment Tradeoff2.3.12The Short-Run Phillips Curve2.3.13The Long-Run Phillips Curve
2.4

Economic Growth, Poverty & Inequality

2.4.1Measuring Economic Growth2.4.2Determinants of Productivity2.4.3Economic Growth & Productivity2.4.4Absolute & Relative Poverty2.4.5Inequality2.4.6Inequality 22.4.7Lorenz Curve2.4.8Government Policy on Poverty2.4.9End of Topic Test - Poverty & Inequality2.4.10Application - Inequality & Poverty
2.5

Fiscal Policy

2.5.1Introduction to Fiscal Policy2.5.2Fiscal Policy and AD-AS Model2.5.3Fiscal Policy Lags2.5.4Automatic Stabilizers2.5.5IB Multiple Choice - Fiscal Policy
2.6

Monetary Policy

2.6.1Objectives of Monetary Policy2.6.2Monetary Policy Implementation2.6.3Monetary Policy & AD-AS Model2.6.4Monetary Policy Lags & Pitfalls
2.7

Supply-Side Policies

2.7.1Supply-Side Policies2.7.2Supply-Side Policies 2
3

The Global Economy

3.1

International Trade

3.1.1Globalisation3.1.2Globalisation for LEDCs3.1.3Globalisation for MEDCs3.1.4Comparative Advantage & Trade3.1.5Protectionism3.1.6Arguments for Protectionism3.1.7Arguments Against Protectionism3.1.8End of Topic Test - Globalisation & Trade3.1.9Case Study - Globalisation & Trade
3.2

Exchange Rates

3.2.1Floating Exchange Rates3.2.2Fixed Exchange Rate3.2.3Effect of a Stronger & Weaker Dollar
3.3

The Balance of Payments

3.3.1Balance of Payments3.3.2Balance of Payments 23.3.3FDI & Reducing a BoP Deficit
3.4

Economic Integration

3.4.1Customs Unions & WTO3.4.2Merged Currency
3.5

Terms of Trade

3.5.1Absolute & Comparative Advantage3.5.2Gains from Trade3.5.3Terms of Trade3.5.4IB Multiple Choice - Comparative Advantage & Trade
3.6

Economic Development

3.6.1Factors Influencing Growth & Development3.6.2International Institutions3.6.3Measures of Development3.6.4Barriers to Development3.6.5Case Study - The Bottom Billion3.6.6End of Topic Test - Emerging & Developing
3.7

The Role of Domestic & International Factors

3.7.1Interventionist Strategies3.7.2Development Strategies3.7.3Development Promotion Policies3.7.4End of Topic Test - Growth & Global Development3.7.5Application Questions -Growth & Global Development
3.8

The Role of International Trade

3.8.1International Institutions3.8.2End of Topic Test - Globalisation & Trade
3.9

The Role of Foreign Aid

3.9.1Aid3.9.2Limitations of Aid3.9.3Support for Aid3.9.4Application Questions - Developing Countries

Practice questions on Consequences of Inflation

Can you answer these? Test yourself with free interactive practice on Seneca — used by over 10 million students.

  1. 1
    Which of the following is a consequence of inflation for firms?Multiple choice
  2. 2
    What are menu costs?Multiple choice
  3. 3
    Consequences of inflation for firms:True / false
  4. 4
    Which of the following factors would worsen the effects of inflation for an economy?True / false
  5. 5
    What can expectations of higher inflation lead to?Multiple choice
Answer all questions on Consequences of Inflation

Unlock your full potential with Seneca Premium

  • Unlimited access to 10,000+ open-ended exam questions

  • Mini-mock exams based on your study history

  • Unlock 800+ premium courses & e-books

Get started with Seneca Premium

The Consumer Price Index

Causes of Inflation