Page 23 - PowerPoint Presentation

> Inflation – the most sinister tax of all

deflationary environment. Due to the minimum wage regulation, employer’s obligations

and workers’ union activities, wages tend to remain high while overall prices drop.

Why would wages behave differently in inflationary periods? In the short run, the inflation

rate will increase with a faster pace than wages. Right? If the same principle is applied to

the inflation period, we will see a significant decline of purchasing power. Prices go higher
before wages adjust.

4.Shoe leather costs
This metaphor describes inefficient resource allocation in an economy. People not willing

to hold money make frequent trips to the bank, wasting time and energy instead of

allocating their efforts towards genuine production and growth.

Inefficiencies caused by inflation are also visible in human behaviour. Inflation seen as a

tax to government alters people’s behaviour. People driven by the incentive not to pay tax

allocate their resources badly causing losses in the economy.

5. Menu Costs

Rapid Inflation causes corporations to lose money. Companies plan prices ahead and

deploy money towards catalogue print outs, price tags etc. If the cost of their “menu” is
significant, companies will experience a loss of revenue due to a rapid rise in price. They

will not be able to keep up with the pace and will be forced to under charge for their

product. Again, inflation causes dead weight losses in an economy.

6. Relative Prices, Mess and Confusion

Extended money supply sends false signals to the markets causing overall confusion and

misinterpretation of the actual facts. Relative prices, in other words prices compared to
other prices in the economy, might vary in inflationary periods. Confusion and instability

of prices on the open market cause investors to make inappropriate decisions. They

allocate resources in an inefficient manner. Their decisions are based on relative price
observation. Inflation disturbs the relative price volatility and causes abnormality in the

market supply.

7. Investment decisions and speculation
Inflation causes money to show up at different values over a period of time. Most

investors on the stock market value their portfolios according to a firm’s profits. If profits

are expressed by revenue minus costs, during inflationary periods, there is a significant
interruption in real values. This causes difficulties in recognising efficiency thus causing

loss on investment.

Inflation sends the price of stocks and commodities artificially high creating an image of
wealth. People speculating in stocks during inflation will allocate money towards those

artificial gains and divert resources from being used more efficiently.

From past experience on the stock market, we conclude that speculative greed ends in
tears and massive revenue losses.