2. Suppose people expect inflation equal to 3%, but prices rise 5%. Describe how this unexpectedly...

2. Suppose people expect inflation equal to 3%, but prices rise 5%.
Describe how this unexpectedly high rate of inflation would help or hurt the following:
a- The government
b- The owner of a home with a fixed interest mortgage.
c- A unionized worker in the second year of the employment contract.
d- A university that has invested part of its money in government bonds.

Expert Solution

Assuming that inflation increases prices to 5%,but people expected prices to rise only upto 3%.

a.)The government:Inflation helps government in many ways.If prices are rised in the economy,then government will be benefited as it receives high revenue income.More income and taxes will be attained by government since people pay higher taxes to consume goods and services.Since government will be in profits,all the loans taken will be cleared.Therefore,inflation will be helpful for government.

b.)The owner of a home with a fixed interest mortgage:The owner of a home with a fixed interest mortgage will not be affected even if high inflation persist.Since fixed mortgages interest are constant and cannot be changed, it is not effected by inflation as there is no chance fto alter the interest rates on fixed deposits,fixed loans,fixed mortgages,etc.So,high inflation rates wouldn't hurt the owner of a home with fixed interest mortgage as he/she needs to pay the same interest rate as it is not affected by inflation.

c.)A unionized worker in the second year as per employment contract:If salaries of uniozed workers are decided by unions then it would be helpful for the employees as those unions would ask for maximum salaries if high inflation exists.But it hurts employees,if salaries are decided by administration or governments as employees cannot attain maximum salaries unless the administration or government decides to maximize it.In other case,if there is contract between employee and employer of paying fixed salary throughout the contract,then such salaries wouldn't be affected by inflation.If the administration or government constantly changes the salaries,then there are chances for employees to lose their jobs after completing the employment contracts.

d.)A university that has invested part of its money in government bonds:High inflation rates hurt university since the cost of government bonds will decrease.If inflation rises,then returns on bonds will increase but the worth of bonds would decline drastically.Hence,the university will be hurted or affected due to high inflation rate.Sudden rise in inlftaion leads to downfall of bond's worth.

Rahul Sunny answered 2 years ago

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