Page 98 - DMGT401Business Environment

Unit 3: Economic Environment of Business

Notes
Example: If there is no inflation, the outcome will be zero tax liability. But if the rate of
inflation is 15% and a person initially pay 100 per share for the stock, for the real price to be the
same a year later, the person sells the stock for 115 per share. In this situation, the tax code
ignores the inflation and will take 15 as capital gain and will tax it.
Hence, an individual is taxed without having any real income and as a net effect, he suffers
a loss.

8. Redistribution: Inflation will redistribute income from those on fixed incomes, such as
pensioners, and shift it to those who draw a more flexible income (like profit makers and
wage-earners), and can keep pace with inflation.
Similarly, it will redistribute wealth from those who lend a fixed amount of money to
those who borrow (if the lenders are caught by surprise or cannot adjust to inflation).

Example: Where the government is a net debtor, as is usually the case, it will reduce this
debt, redistributing money towards the government.
9. Reduction in Investment and Savings: Sometimes inflation causes uncertainty in the
economy, which discourages investment and savings in countries.
10. Vicious Circle of Inflation: An increase in inflation increases, it increases the tax on holding
currency, and therefore encourages spending and borrowing, which increase the velocity
of money. Such reinforcing of the inflationary environment creates a 'vicious circle'.
Carried to extremes it can become hyperinflation.

Impact of Inflation on Different Groups

1. Loan Agreements/Future Contract/Future Payments: Inflation leaves its impact on loan
agreement as it influences the gains/losses of debtors and creditors. In a loan agreement,
if inflation turns out to be higher than expected, the debtor wins and the creditor loses
because the debtor repays the loan with a less valuable rupee. On the other hand, if
inflation turns out to be lower than expected, the creditor wins and the debtor loses
because the repayment is worth more than the two parties anticipated.
2. Producers and Traders: Producers, traders and speculators gain during inflation as price
rises faster than the cost and therefore their profits rise. The money value of their inventories
also rises during inflation.
3. Fixed Income Group: Inflation has an adverse impact on wage earners and salaried people
as it erodes their real income. Moreover, in trying to push up wages to sustain their real
income, wage earners bring about cost-push inflation and in the process worsen their
position.
4. Investors: Investors investing in debentures and fixed interest bearing securities, bonds,
etc., lose during inflation. But investors investing in equities benefit because more dividend
is yielded on account of the high profits made by companies during inflation.

Task Consider the recent inflation that hit the economy and make note of the
changes that you saw in the general marketplace.

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