This essay focuses on inflation in an economy. Inflation can also distort purchasing power over time for recipients and payers of fixed interest rates. Take pensioners who receive a fixed 5 percent yearly increase to their pension. If inflation is higher than 5 percent, a pensioner’s purchasing power falls.
Assignment for Business Economics [AFE7504-A] Question 1: In which ways do you think the minimum wage may impact the level of employment and inflation in an economy? Cite comparative examples of the developing and the developed economies to support your assertions.(50 marks) Question 2: How do the main components of aggregate demand contribute to GDP growth? Which elements of the aggregate demand do you think caused the global economic recession during the Covid-19 pandemic?
To the extent that households’ nominal income, which they receive in current money, does not increase as much as prices, they are worse off, because they can afford to purchase less. In other words, their purchasing power or real—inflation-adjusted—income falls. Real income is a proxy for the standard of living. When real incomes are rising, so is the standard of living, and vice versa.
In reality, prices change at different paces. Some, such as the prices of traded commodities, change every day; others, such as wages established by contracts, take longer to adjust (or are “sticky,” in economic parlance). In an inflationary environment, unevenly rising prices inevitably reduce the purchasing power of some consumers, and this erosion of real income is the single biggest cost of inflation.
Inflation can also distort purchasing power over time for recipients and payers of fixed interest rates. Take pensioners who receive a fixed 5 percent yearly increase to their pension. If inflation is higher than 5 percent, a pensioner’s purchasing power falls. On the other hand, a borrower who pays a fixed-rate mortgage of 5 percent would benefit from 5 percent inflation, because the real interest rate (the nominal rate minus the inflation rate) would be zero; servicing this debt would be even easier if inflation were higher, as long as the borrower’s income keeps up with inflation. The lender’s real income, of course, suffers. To the extent that inflation is not factored into nominal interest rates, some gain and some lose purchasing power.