Page 203 - DECO402_Macro Economics

Macroeconomic Theory

Notes 1. Effects on Production and Economic Activities
Creeping like inflation may have a powerful effect on production, employment and in this manner,
on economic activities. For an economy suffering from lack of demand, wheels of industries are well
greased for increasing the production from the increased expense and for generating employment.
Because of increased prices, increased amount of profits induce the firms for more investment, because
of which unemployed human power and unused resources may get employment. As a result of this
more income will be generated, by which increase in demand will be induced. Under any circumstance,
at least initially losses of fixed income group will be less than the profits of rest of the community.
Employment of labours may make them better also.
Along with time, when inflation goes beyond the limits, it creates a chaos in the economic system. It
may result in reduction in production and increase in unemployment, because in future for earning
more profit, firms consider accumulation to be more profitable instead of production. There may
be obstacle in production due to labour strike of those labourers whose actual income had declined
during the inflation period. Sometimes, for earning more profits, producers may reduce the quality
of goods and services produced.

2. Effects on Distribution of Income
Inflation does not affect all sections of the society equally. Some people attain profits by inflation, other
people incur losses; how badly people suffer losses, it depends on that amount of income or property
that inflation takes away from them. If all prices had risen in the same direction and to the same
limit, then effects of inflation would not have been noted. If increase in price of goods and services,
like 20 percent, had been equated by proportionate increase in wages, rent, profits etc, then people’s
purchasing power and because of this lifestyle would have been unaffected. Practically, all prices are
not changed at the same rate. Hence inflation causes profit to some (people) and loss to some (people).
Effects of inflation on various classes of the society may now be explained:
a. Producers: Here in the class of producers, manufacturers, traders and farmers are included.
They all obtain profits during the period of inflation. Prices of goods increase at a faster rate
than the cost of production. There is always a time gap between increase in prices of goods
and increase in cost of inputs like wages, interest, rent, insurance premium etc. that is why
their profit margins may also increase. Producers and traders also may reap huge profits by
creating an artificial scarcity of goods, because of which prices increase further. Along with
marketable surplus, big farmers also have profits from price rise, especially those farmers
who produce inflation sensitive crops. Generally price of these crops rise at a faster rate as
compared to manufactured goods. Inflexible demand for agricultural goods motivates farmers
to stock goods, so that they may be sold at a higher price in the future. Small farmers who
are engages in livelihood earning farming are not much affected by inflation.
Because of uncertainty created by the continuously increasing price level, inflation induces
the activities of speculation. For earning higher profits, producers and traders also instead
of investing more money in production activities, are engaged in speculation. In this way,
producers earn huge profits during inflationary period.
b. Debtors and Creditors: Debtors are those people who borrow money and repay it in future
along with the interest. As a result of inflation debtors are at profit because, actual value of
money that they pay back falls down because of inflation. Apart from this, they by repayment
during inflation make less sacrifice in form of goods and services, because inflation reduces
the value of money and in this way its purchasing power. It can be understood with the help
of an easy example. Assume that today Nihit takes a loan of ` 100 on an interest @ 10% p.a. if
after a year at the time if repaying the loan and interest economy is in inflation, then value of

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