MACROECONOMICS

ASSIGNMENT ON SOCIAL COST OF INFLATION

CENTRAL UNIVERSITY OF

BIHAR CENTRE FOR ECONOMIC STUDIES

AND

POLICIES

GROUP MEMBER

RAJNISH KUMAR

RAUNAK NAVIN

INFLATION Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase.

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THE LAYMAN’S VIEW

If you ask the average person why inflation is a social problem, he will probably answer that inflation makes him poorer. “Each year my boss gives me a raise, but prices go up and that takes some of my raise away from me.’’ The implicit as -sumption in this statement is that if there were no inflation, he would get the same raise and be able to buy more goods

SOCIAL COST

Social cost is the total cost to society. It includes both private costs plus any external costs

The social costs of smoking include the passive smoking that other people experience.

IMPORTANCE OF SOCIAL COST

Rational choice theory suggests individuals will only consider their private costs. For example, if deciding how to travel, we will consider the cost of petrol and time taken to drive. However, we won’t take into consideration the impact on the environment or congestion levels for other members in society.

Therefore, if social costs significantly vary from private costs then we may get a socially inefficient outcome in a free market.

SOCIAL COST OF INFLATION

Almost everyone thinks inflation is evil, but it isn't necessarily so. Inflation affects different people in different ways. It also depends on whether inflation is anticipated or unanticipated. If the inflation rate corresponds to what the majority of people are expecting (anticipated inflation), then we can compensate and the cost isn't high. For example, banks can vary their interest rates and workers can negotiate contracts that include automatic wage hikes as the price level goes up.

THE SOCIAL COSTS OF INFLATION

…fall into two categories:

1. costs when inflation is expected

2. costs when inflation is different than people

had expected

1. SHOE LEATHER COST

def: the costs and inconveniences of reducing

money balances to avoid the inflation tax.

↑π ⇒↑i

⇒ ↓ real money balances

Remember: In long run, inflation does not

affect real income or real spending.

2. MENU COSTS

def: The costs of changing prices.

3. RELATIVE PRICE DISTORTIONS

Firms facing menu costs change prices infrequently.

4. UNFAIR TAX TREATMENT

Some taxes are not adjusted to account for

inflation, such as the capital gains tax.

THE COST OF UNEXPECTED INFLATION

Arbitrary redistribution of purchasing power Ex: From lenders to borrowers

Increased uncertainty