The Economic Significance Of Inflation?

Question

The Economic Significance Of Inflation?

Answer 1

Inflation is considered one of the most significant economic problems.

ECONOMIC GROWTH

In the long terms, inflation will create an unfavourable economic environment of low business confidence and generate consumer pessimism. Businesses become less likely to undertake capital investment, and it becomes more likely that economic growth is stagnated by sluggish levels of aggregate demand and expenditure.

INCOME INEQUITY

Inflation can also cause higher levels of inequity in income distribution, because lower income earners need to spend a higher portion of their income to purchase goods and services, leading to low income households having reduced levels of discretionary income.  

EXTERNAL STABILITY

Inflation contributes to businesses COP (cost of production), making exports less competitive because they become relatively more expensive. This negatively impacts upon the Balance on Goods and Services, and thus causes the CAD to deteriorate.

RESOURCE ALLOCATION

Inflation represents inefficiency in resource allocation because it adds to the COP, and reduces the ability of businesses to invest in capital works which will improve aggregate supply and efficiency in the long run.

FULL EMPLOYMENT

Due to dampened levels of demand, production levels and employment levels should fall (see the economic activity cycle), because businesses do not want to produce goods or provide services which will not be purchased by the consumer.