Inflation is a sustained increase in the aggregate price levels. It refers to a state of rising prices and not a state of high prices. Before start reading about effects of inflation you should know what causes inflation.
If there is an excess of aggregate demand in the economy over aggregate supply, the general price level will tend to increase, which leads to inflation.
On the other hand Producers increase the prices of goods and services to maintain the profit rates after an increase in the cost of production, which leads to inflation.
Now you understand what causes inflation, it’s time to know effects of inflation.
Effects of Inflation
Effects of Inflation on Purchasing Power of Money
Purchasing power of money means the amount of goods and services which a unit of money can buy. During inflation,
people will be able to consume lesser goods and services than before, i.e. real income declines.
Effects of Inflation on Production
When hyperinflation occurs in an economy because of uncertainty, there will be a negative effect in the production. It disrupts the price system and encourages hoarding. Hyperinflation reduces savings and capital accumulation which adversely affects production.
Effects on Distribution
Fixed income groups:
People who receive a fixed income are hit the hardest during periods of rising
prices as their incomes remain fixed. The middle class, who by hard work take care of their children’s education, find it difficult to survive in times of serious inflation.
During inflation, when the prices rise and the real value of money goes down, the debtors pay back less in real terms than what they had borrowed, and thus to that extent they are gainers. On the other hand, the creditors get less in goods and services than what they had lent and hence lose in that context.
When prices rise, the returns on equities go up on account of the rise in profits, while the bond and debenture holders gain nothing as their income remains fixed. By the same logic, holders will lose during depression, while the debenture and bond holders will stand to gain.
Meaning and Functions of Money