Learning Objectives

Costs and Benefits of Inflation

Inflation is the appreciable rise in the general level of prices. This can benefit members of society as their wages and standard of living increase. However, inflation can also have adverse effects on society if price levels of goods and services rise faster than the rate of income levels.

For this reason, there are groups of people that benefit from high levels of inflation:

- Holders of assets

- The government

- Debtors

There are also groups that suffer from high inflation:

- People on fixed wages or pensions

- Creditors

- Taxpayers

The general level of inflation has effects on the level of output, income and employment as well as the distribution of income and wealth in the economy. The government set target for inflation rates is between 2-3% per year to ensure price stability and consistent growth.

Inflation effects on the level of output, income and employment

Real incomes

Real incomes of consumers will decrease, and in turn, their purchasing power decreases also. This means that households cannot purchase the same amountof goods and services as they were able to before inflated prices rose faster than their income.

Economic efficiency

The efficiency of the economy decreases as people start to invest in assets that they expect to increase in value with the inflation rates. Examples of these include valuable art, gold or stocks. These goods do not benefit the productivity of the economy, and therefore, efficiency decreases as money isn't invested into the productivity of the economy.

Uncertainty

High levels of inflation can result in uncertainty from consumers and firms as their confidence in the economy falls. Their ecpectations of future prices and their purchasing power may promote savings, and inturn, less investment and spending throughout the economy. Furthermore, the Lack of Confidence from consumers may arise as fears of future prices and aggregate demand increase.

Capital Resources Replace Labour

As the cost of wages increase, businesses will look for cheaper alternatives. Therefore, capital machienery are common substitutes for human labour. This results in a increase in unemployment levels.

Real interest rates

– inflation taken out; real interest rates fall

International competitiveness

If the level of inflation within Australia is higher that the level of inflation in foreign countries, then the demand for our exports will fall. This means that Australia becomes less competitive to overseas competitors.

Hyperinflation – when inflation gets out of control, it can cause the economy and currency

to collapse; people lose confidence in money as a measure of store value