Effects of Inflation explain the effects of

Effects of Inflation • explain the effects of inflation on households and firms • explain the effects of inflation on growth and trade

Inflation and Households • Purchasing power: – Inflation reduces purchasing power (get less for same price). • i. e. family on an income = $100/week, they buy one product worth $5. This means they can purchase 20 of this good. But if the price were to increase to $10 for the product they could now only purchase 10. – Standard of living has declined. – If a households income increases with inflation the price increases will not hurt their purchasing power. Fixed income households will suffer a decrease in purchasing power.

Inflation and Households • Inflationary expectations: – When we expect inflation to occur, we buy goods and services before we normally would to beat the price rise, but instead help cause inflation.

Inflation and households • To control inflation the RBNZ may rise the OCR. This leads to interest rates increasing, and in turn decreasing consumer spending…. .

Interest Rates and Households • Interest rates are the price of money: savers receive interest as the price paid to them by borrowers for the use of their money. • Increase in interest rates: – cost of borrowing increases which will discourage consumers from purchasing goods and services on credit (loan, mortgage, credit card, hire purchase) therefore consumption will decrease. – Increase in return from savings which will encourage people to save, therefore consumption will decrease.

I would like to borrow $100 please Mr Krabs, to buy Gary a new bed meow Ok, I will lend you $100 but in one year you must pay back 6% interest

MEANWHILE Prices in bikini bottom are rising at 10%! Who will be better off in a years time, Mr Krabs or Spongbob?

Here’s your $106 Mr Krabs But…. Prices have rose by !0%, if I wanted to buy a new cash register a year ago I would only have to pay $100, now I have to pay $110

Inflation and Borrowers vs. Lenders • Borrowers will become better off in times when the inflation rate is more than the nominal interest rate. – Example: say you borrow $100 at an interest rate of 6% at a time when prices are rising at a rate of 10%. In one years time you will repay $106. – The lender receives this back, but if they (the lender) wanted to buy the same good you bought for $100 a year ago they must now pay $110 for it (due to 10% inflation) and so cannot afford it now. They could have afforded it at the time you borrowed the money. – The real rate of interest would be -4% (the nominal interest rate – inflation = real interest rate). Therefore making savers worse off than borrowers.

Interest Rates and Households • Decrease in interest rates: – Cost of borrowing decreases which will encourage people to purchase more goods and services on credit, therefore consumption will increase. – Decrease in return from savings which will discourage people to save, therefore consumption will increase.

Firms and Inflation • Firms also get hit by inflation: – Increased costs of resources • Resources cost more to buy profits down. – E. g. materials, fuel. – Firms will either pass increased costs to consumers by increasing price (which can cause a decrease in demand for their product) OR they will keep the price the same and decrease their profits.

Firms and Inflation – Increased demand for wage rises • Firms will feel pressure from unions to pay higher wages if inflation continues to exist. • This reduces their profits and may cause redundancies.

Double hit to firms • The RBNZ will try and minimise the effects of inflations and will increase the OCR causing higher interest rates (more expensive to invest by firms). • Higher interest rates attract Foreign Investment to NZ. • This increases the demand for the $NZ, therefore appreciation of the $NZ.

• Export receipts will drop as it becomes more expensive for overseas consumers to buy our exports. • Imported raw materials become relatively cheaper

Growth and Inflation • Growth is an increased amount of GDP being produced each year. – GDP= AD = C + I + G + (X – M) – If the horizontal axis on our AD/AS model changes this effects NZ Growth. – How will inflation effect Growth? ? ?

Trade and Inflation • Inflation pushes NZ costs of production up – E. g. a good that costs $100 to make will soon cost $110 to make. • The higher costs of production will then usually be passed onto consumers (our international trading partners). • Our goods become relatively more expensive compared to our international competitors, therefore we lose out international competitiveness. X decreases (decreasing net exports). • Imports now become relatively cheaper so M will increase (decreasing net exports).

• Planning: • http: //tutor 2 u. net/economics/content/topics /inflation/costs_of_inflation. htm • http: //everything 2. com/title/The%2520 effec ts%2520 of%2520 inflation