Inflation affects different aspects of the economy. In this article, we will explore the effects of inflation on production activities and the distribution of wealth.
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Effects of Inflation on Production
Inflation has the following effects on production activities:
- Inflation may or may not result in an increase in production
- As long as the economy does not reach the full employment stage, inflation has a favorable effect on production
- Usually, as the price level increases, profits increase too
- During inflation, businessmen tend to raise the prices of their products to earn better profits
- However, if the wages and production costs start rising rapidly, then this favorable effect of inflation does not last long
- If the inflation in an economy is of the cost-push type, then the inflationary situation usually leads to a fall in production
- There is no direct correlation between prices and output
Browse more Topics under Money
- Definition and Functions of Money
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Effects of Inflation on the Distribution of Wealth
Source: PxHere
Inflation has the following effects on the distribution of wealth:
- Usually, during inflation, most people experience a rise in their income levels
- Some people might gain at the cost of others. As the sellers will be able to sell the goods at a higher rate to its customers due to inflation.
- A certain set of people gain because their money income rises faster than the prices
- A different set of people lose because prices rise faster than their incomes during inflation
Learn more about Economic Development here in detail.
Effects of Inflation on Different Categories of People
Let’s look at how inflation affects different categories of people.
Debtors and Creditors
- During inflation, borrowers tend to gain. Hence, lenders tend to lose.
- Borrowers gain because they repay less in real terms as compared to when they had borrowed the money
- Lenders lose because when they receive repayment of their debts, the real value of their money declines by the amount of increase in the price levels
- In other terms, a borrower receives ‘dear rupees’ but pays back ‘cheap rupees’.
Bond and Debenture Holders
- Debenture and Bond Holders earn fixed income on their investments
- Therefore, when the price levels rise, they suffer a reduction in real income
- Beneficiaries of life insurance programs also suffer badly because the real value of their savings deteriorates
Investors
During inflation, businesses have an opportunity to earn good profits. Therefore, people who invest in shares during inflation tend to gain. As the businesses earn higher profits, they usually distribute the profit among investor and shareholders too.
Salaried People and Wage-earners
During inflation, people earning a fixed income face a lot of damage because the rate of increase in wages is always behind the rate of increase in prices.
Therefore, inflation results in a drop in the real purchasing power of people earning a fixed income. Hence, people earning a flexible income tend to gain during inflationary periods.
Profit Earners, Speculators, and Black Marketeers
- During inflation, the profit-earners gain
- Businessmen also raise the prices of their products and earn bigger profits
- Speculators gain by inflation, especially when the prices of factors of production increase too
- Black marketeers tend to gain since the price of products increases with time
Solved Question
Q1. What are the effects of inflation on production activities?
Answer: Inflation may or may not result in an increase in production. Also, inflation has a positive impact on production as long as the economy does not reach full employment stage. Further, if the wages and production costs start rising rapidly, then it negatively impacts production activities.
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