P.G. II Social Cost of Inflation by Pranav Shekhar
P.G. II Social Cost of Inflation by Pranav Shekhar
P.G. II Social Cost of Inflation by Pranav Shekhar
INFLATION
PRANAV SHEKHAR
ASSISTANT PROFESSOR,
ECONOMICS
PPT FOR P.G.2ND SEMESTER AND B.A PART 1
BASIC CONCEPT OF INFLATION
• Demand-Pull Effect
• Demand-pull inflation occurs when the overall
demand for goods and services in an
economy increases more rapidly than the
economy's production capacity. It creates a
demand-supply gap with higher demand and
lower supply, which results in higher prices.
For instance, when the oil producing nations
decide to cut down on oil production, the
supply diminishes. It leads to higher demand,
which results in price rises and contributes to
inflation.
SOCIAL COST OF INFLATION
• Expected Inflation:
• Consider first the case of expected inflation. One cost of expected
high inflation is the distortion of the inflation tax on the amount of
money people hold. A higher inflation rate leads to a higher nominal
interest rate which, in turn, leads to lower real balances. If people
are to hold lower money balances on average, they must make
more frequent trips to the bank to withdraw money. The
inconvenience of reducing money holding is called the shoe-leather
cost of inflation.
• A second cost of inflation arises because high inflation induces
firms to change their prices more often. Changing prices is
sometimes costly: for example it may require printing and
distribution of a new catalogue. These costs are called menu costs,
because the higher the rate of inflation, the more often restaurants
have to print new menus.
EXPECTED INFLATION
• A third cost of inflation arises because firms facing menu costs
change prices infrequently: thus, the higher the rate of inflation, the
greater the variability in relative price. Since market economics rely
on relative prices to allocate resources efficiently, inflation leads to
microeconomic inefficiencies.
• A fourth cost of inflation results from the tax laws. Many provisions
of the tax code do not take into account the effects of inflation.
Inflation can alter individual’s tax liability, often in the ways that
lawmakers did not intend.
• A fifth cost of inflation is the inconvenience of living in a world with
a changing price level. Money is the yardstick with which we
measure economic transactions. When there is inflation, that
yardstick is changing in length. For example, a changing price level
complicates personal financial planning.
• Another important point is that money invested in present age will
yield fixed rate of return but value of money may fall to a greater
level because of inflation.
UNEXPECTED INFLATION