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Unit 2

2.5 Costs of Inflation

2 min readโ€ขdecember 31, 2020

Jeanne Stansak

Caroline Koffke


2.5: Costs of Inflation

There are a variety of costs associated with unanticipated inflation. Remember that inflation is a general rise in prices. Economists will make predictions about possible inflation rates based on the current state of our economy however there are times when their predictions are not accurate. As a result of the change between predictions and what the inflation rate actually is there are costs that result. These costs include menu costs, shoe-leather costs, loss of purchasing power, and redistribution of wealth.

Menu costs result from a firm having to change prices. As inflation occurs within our economy, businesses are forced to change any business-related materials that have prices on them like a menu as a result. An example of this would be Walmart having to hire additional workers to replace all the price tags on their products every week. Another example is the owner of a restaurant having to spend an extra three hours a week creating and updating coupons.

Shoe leather costs refer to the cost of time and effort that people end up spending to counteract the effects of inflation. For example, businesses may hold less cash or have to make additional trips to the bank during inflation. A good example of this is each month your rent increases so you can't set up an online automatic payment and as a result, have to pay cash and deliver the rent in-person to your landlord.

Loss of purchasing power occurs because inflation causes the value of the individual dollar to decrease over time. For example, individuals who have the same wage next year as they do currently will not be able to purchase as much. For example, if an individual earns a salary of $60,000 and the inflation rate rises from 3% to 5% from 2018 to 2019 than that salary will not be able to purchase as much in 2019 as it was in 2018.

Wealth redistribution involves the real value of wealth being transferred from one group to another. (i.e. borrowers and lenders). When people are considering lending or borrowing money, they will take into consideration the expected inflation rate. If that inflation rate turns out to be different than anticipated, that affects the amount of interest that is repaid or earned.

Lenders will be hurt by unanticipated inflation because the money they get paid back with has less purchasing power. Borrowers, on the other hand, benefit from unanticipated inflation because the money they payback is worth less than the money they borrowed.

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