Page 97 - DMGT401Business Environment

Business Environment

Notes
Example: The form of more frequent trips to the bank (there is a humorous reference to
the cost of replacing shoe leather worn out when walking to the bank).
3. Menu costs: Under inflation, firms must change their prices more frequently, which imposes
costs.

Example: A restaurants have to reprint their menus as they change them menu time and
again.
High inflation induces firms to change their posted prices more often. Changing prices is
a costly affair as it requires printing and distributing new catalogues.
4. Variability in Relative Prices: The higher the rate of inflation, the greater the variability
in relative prices. To adjust to inflation firms usually change their price after specific
intervals, usually annually. But prices don't increase annually. They increase daily, weekly
or monthly, and this results in variability in prices.

Example: Suppose a firm increase its prices to adjust inflation every April. But if inflation
is 1% per month, then from the beginning to the end of the year, the firm's relative prices fall by
12%. Sales from this catalogue will tend to be low early in the year (when its prices are relatively
high) and high later in the year (when its prices are relatively low).

Hence, when inflation induces variability in relative prices, it leads to inefficiencies in the
allocation of resources.
5. Negative Impact on Exports: This happens if the inflation in an exporting country is
higher than inflation in the importing country. If the nominal exchange rate is not adjusted
by the inflation differential then inflation causes appreciation of home currency in relation
to the foreign currency. The appreciation in the real exchange rate adversely affects net
exports.

In another sense, inflation results in higher procurement or manufacturing costs in the
home country but if inflation is lower in the importing country, then the selling price will
not increase by that magnitude. This reduces profits and increases competition for the
export market from other exporting countries that have low inflation. Inflation thus reduces
from exports.
6. Change in Yardstick: Money is a yardstick with which we measure economic transactions.
But this yardstick changes when inflation occurs. In such an instance it becomes difficult to
measure economic variables. The comparision of the economic variable of the country at
different periods is an especially difficult task.. Comparing the per capita income of an
Indian in 1980 and in 2000 will be of no use as it will not give true picture of his economic
capacity. As we compare the size of the economy through the traditional route, that is by
Per Capita GDP in Dollars, we find that India ranks through very low. But if we do
through with the new route, i.e., Purchasing Power Parity (PPP), then we find that India is
among the top five. This shows how difficult it is to compare economic data because of
inflation.

7. Tax Anomaly: Inflation distorts the way taxes are levied. Because of inflation, a person can
be taxed without having any income. Suppose a person buys some stock today and sells
the same a year from now at the same real price. It would seem reasonable for the
government not to levy a tax, since there is no income.

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