The Cause and Effects of Inflation

Topics: Monetary policy, Central bank, Federal Reserve System Pages: 3 (896 words) Published: August 17, 2010
The Cause and Effects of Inflation

Chris Hinman

Most people are aware that inflation is a continuing rise in the general level of prices, but it is also important to know the causes and effects of inflation as well. It is also important to understand that inflation is self-sustaining and can act as a snowball effect. Consumers expecting a rise in prices may increase spending, causing the market prices to rise. In the periods of higher prices, producers may be more inclined to increase wages and other costs, because these higher costs can be passed on to the consumer in the form of increased prices. These higher prices become the basis for further increases in production costs and higher prices, and the snowball effect begins.

Inflation has a huge effect on our economy as it affects the distribution of income, the allocation of resources and the output of resources. These three effects are the major effects of inflation and are generally referred to as Equity effects, Efficiency Effects, and Output Effects. Equity effects generally refers to the alteration in the distribution of income. This alteration can cause harm or good, depending on the particular individual and their source of income. An individual on a fixed income may be harmed by inflation as they are losing some of the value of their salary. Their purchasing power is reduced because their $25,000 salary will not buy as much as it did previously because the prices of goods and services has increased, while their salary has remained the same. Savings bonds and other fixed money can also be hurt by inflation as well. On the other hand, those who depend on income in the form of profits may benefit. Business owners and owners of stocks may see this if the rate of profits rises faster than the rate of inflation.

Efficiency effects involve the changing of resource allocation. Because inflation increase demands for goods and services the supply for these goods and services are also increased....
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