Favorable and Unfavorable Impacts of Inflation on Economy

Inflation is not necessarily bad for the economy. For example, creeping inflation can generate good effects on the overall economy of a country. In this article, we will look at the favourable and unfavourable impacts of inflation.

Favourable Impacts of Inflation

The favourable impacts of inflation are as follows:

Higher Profits

Inflation, usually, benefits the producers of products. They experience better profits since they can sell their products at higher prices.

Better Investment Returns

During inflation, investors and entrepreneurs receive added incentives for investing in productive activities. Therefore, they receive better returns.

Increase in Production

Once the producers receive the right investment, they create more goods and services. Hence, inflation leads to an increase in production of products/services.

More Employment and Better Income

Since production increases, there is an increased demand for the various factors of production, including manpower. Therefore, employment and income increases during inflation.

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Learn more about Role and Contribution of Major Industries in Indian Economy here in detail.

Shareholders can earn a good income

If a company earns higher profits, which is possible during inflation, it can declare dividends to its shareholders. Thus, the shareholders can experience a rise in their dividend income during inflationary periods.

Benefits to Borrowers

During inflation, the purchasing power of money decreases. Therefore, if the borrower is paying a rate of interest which is less than the inflation rate, then he gains in the process. This is because the real value of the money that the borrower returns is actually less than that of the money borrowed.

impacts of inflation

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Unfavourable Impacts of Inflation

The unfavourable impacts of inflation are as follows:

Fixed-Income Groups experience a fall in income

The true income of an individual is the purchasing power of his money income. In other words, $$Real Income =\frac {\text{Money Income}}{\text{Price Level}} $$.

For people belonging to the fixed-income group like salaried individuals, pensioners, etc. this means that they will experience a fall in real income. In other words, their purchasing power will reduce.

Inequality in Income Distribution Increases

During inflation, businessmen and entrepreneurs experience an increase in profits. On the other hand, people belonging to the fixed-income groups experience a decline in their real income. Hence, the inequality in income distribution becomes acute during this period.

Upsets the Planning Process

During inflation, the prices of goods, raw materials, and factor services increase. Therefore, the Government has to spend more money to complete any investment project taken up during the planning period.

If the Government fails to raise more financial resources through savings or taxation, then it upsets the entire planning process.

Speculative Investment Increases

Let’s say that the price levels are rising at a very fast rate. People are unsure about how much the prices will rise in the next few weeks or months. In such cases, many people start speculative investments.

For example, they might start purchasing shares, gems, land, etc. just for speculative purposes. This is done with the objective of earning quick profits. Such investments do not help in creating productive capital in the economy.

Harmful Effects on Capital Accumulation

Let’s say that rising prices become chronic in an economy. During such periods, people start preferring goods to money since the real value of money will fall in the future. Also, people start preferring immediate consumption to consumption in the future.

Therefore, the general desire to save starts reducing. As the willingness and ability to save reduces, the amount of funds available for further investment reduces too. Therefore, the overall impact on the capital accumulation of the economy is negative since capital accumulation in an economy depends on the growth of investment.

Lenders face Losses

Under favourable impacts of inflation, we mentioned that borrowers benefit from inflation. Therefore, lenders stand a chance of losing during such periods. This is because they receive an amount having lower purchasing power than the amount loaned.

Negative Impact on Export Income

Since the prices of raw materials and factors of production increase, the prices of export items also increase during inflation. Hence, their demand in the foreign markets might fall which leads to a fall in the export income of the country.

Solved Questions on Impacts of Inflation

Q1. What are the favourable impacts of inflation on the economy?

Answer: Inflation favourably impacts the economy in the following ways:

Higher Profits since producers can sell at higher prices
Better Investment Returns since investors and entrepreneurs receive incentives for investing in productive activities
Increase in Production
More Employment and Better Income
Shareholders can earn a good income since companies book more profits and tend to share it with their shareholders via dividends
Benefits to Borrowers – The real value of the money returned is less than that of the money borrowed

Q2. What are the unfavourable impacts of inflation on the economy?

Answer: Inflation unfavourably impacts the economy in the following ways:

Fixed-Income Groups experience a fall in income including salaried employees, pensioners, etc.
Inequality in Income Distribution Increases
Upsets the Planning Process
Speculative Investment Increases
Harmful Effects on Capital Accumulation
Lenders face Losses
Negative Impact on Export Income

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Impacts of Inflation

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