Effects Of Inflation Assignment Help | Effects Of Inflation Homework Help


Most of the economists are of the opinion that a mild inflation is not merely desirable, but also a necessary condition of economic growth. This is particularly true for undeveloped countries like India, where manpower is unemployed and mobilization of resources is a difficult task. In these countries, inflation helps in raising resources, which will not be otherwise available. However, when inflation gallops and takes the form of hyper inflation, the whole economy is shattered. In such a situation, the planning system is upset and the process of economic development may come to a halt. The effects of inflation can be studied under three heads.

1. Effects on Production and Economic Activities

Inflation of a creeping or crawling form (whether demand pull or cost push) may have a tonic effect on production, employment and hence economic activities. The wheels of industries are well lubricated to raise production and create jobs through increased spending for economies suffering from deficiency of demand. The wind fall profit margins due to rise in prices induce firms to invest more, which may lead to employment of unemployed manpower and unutilized resources. This will result in capital formation and creation of more income, leading to an increase in demand. In any case, the losses to the fixed of income group are less than the gains to the rest of the community, at least in the very beginning. Employment of workers may even make them better off. In course of time, when inflation goes beyond a certain limit, it creates chaos in the economic system. It may result into reduction in production and rise in unemployment, as firms find it profitable to hoard rather than produce to earn more profits in the future. Production may also be interrupted on account of bitter labour strikes by workers whose real income fell during inflation period. Sometimes, producers may even decline the quality of goods produced to secure greater profits.

2. Effects on Distribution of Income

Inflation does not affect all the sections of society equally. It is rather accompanied by sizeable, haphazard and undesirable shifts in the distribution of income. Some people gain from inflation, others get hurt. How badly people get hurt depends upon the amount of income and wealth that inflation takes away from them. Had all prices rose in the same direction and by the same extent, the effects of inflation might have been ignored. If increase in the price of goods and services by, say, 20 percent is compensated by a proportionate rise in wages, rent, profit, etc., the purchasing power and hence, the standard of living of the people remain unaffected. In practice, all prices do not change at the same rate. Therefore, inflation provides gains to some and losses to others. The effects of inflation on different sections can now be discussed on various groups of the society.

(a) Businessmen

The group of producers, here, include manufacturers, traders and farmers. They all gain profits during the inflation period. The prices of goods rise at a much faster rate than the cost of production. There is always a time lag between increase in the price of goods and the prices of inputs like wages, interest, rent, insurance premia, etc. Hence, their profit margin rises. The producers and traders also generate huge profits by creating artificial scarcity of the goods, causing further price hike. Big farmers with marketable surplus also gain from the price rise, especially those farmers who grow inflation sensitive crops. The prices of these crops generally rise faster than the prices of manufactured goods. Inelastic demand for the agricultural goods induces farmers to hoard the goods, so as to sell them at higher price in the future. Small farmers, engaged in subsistence farming are not much affected by inflation.

(b) Debtors and Creditors

A rise in piece level alters the real burden of debts and hence affects debtors as well as creditors. Debtors are the ones who borrow money and repay it in future with interest thereon. They gain as a result of inflation, since the real worth of money which they repay declines on account of inflation. Further, they forgo less in terms of goods and services by repayment during inflation, since inflation reduces the value of money and hence the purchasing power.

(C) Investors

Investors in equities generally get benefits due to inflation. During inflation, firms make huge profits. So, the shareholders on one hand earn dividends. On the other hand, they may secure capital gains on account of rise in the price of shares. Investors in fixed interest yielding bonds and debentures suffer, as the real income from such investment declines during inflation. When the inflation is severe, the hard earned savings are completely wiped out due to fall in the value of money. Small investors suffer the most who keep their savings in the fixed deposit or saving bank accounts, provident funds and insurance schemes. That is why, people prefer to spend more in purchasing consumer goods. They are reluctant to save. With the reduced savings, capital formation and credit is adversely affected Consequently, investment in the productive economic activities suffers a set back. This will have serious repercussions for the economic development of an underdeveloped country like India, where more than three-fourths of total savings originate in the household sector.

(d) Fixed Income Earning Class

Wage salary earners and other individuals with fixed incomes are most severely hit by inflation. Increase in salaries through annual increments or untimely payments of dearness and other allowances fail to keep pace with the rising prices. Other individuals include pensioners, fixed interest and rent earners. Their money income remains more or less fixed, while the prices of the goods and services which they intend to purchase are rising very rapidly. They lose because the purchasing power of their earnings fall. The same is the case with the holders of fixed interest bearing deposits. Workers employed in the large organized sector may be able to pressurize the management to raise the wages through strong trade unions. However, workers employed in the small sector are unable to do so, as either they are unorganized and ignorant or their unions are very weak. They are unable to secure escalator clause in the wage contracts so as to force the employer to compensate workers for erosion in their real income on account of price rise. Further, there is often a time lag between the raising of wages by employers and the rise in prices. Workers lose because by the time wages are raised, the cost of living index may have increased further. The most hardly hit wage earners will be those who have entered into contractual wages for a fixed period, while prices continue to rise during the period of contract.

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