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 then 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 Ok, I will lend you $100 but in one year you must pay back 6% interest meow

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).

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