Question

Chapter 11, 12: Money and Inflation

Reference: Brief Principles of Macroeconomics textbook

III. Define the following costs of high inflation and find examples.

1. Menu costs

2. Shoeleather costs

3. Confusion and inconvenience

4. Distortions in relative prices and the allocation of resources

5. Tax distortions

6. Arbitrary redistributions of wealth

Answer 1

1) Menu costs- is the cost to a firm resulting from changing prices such as printing new menus,mailing new catalogs etc

2) Shoeleather Costs - the resources wasted when inflation encourages people to reduce their money holdings.It includes the time and transactions costs of more frequent bank visits for withdrawals hence the name shoelather.

3) Confusion and Inconvenience - Inflation changes the yardstick we use use to measure transactions.It complicates long range planning and the comparison of amount of given currency over time.

4) Distortions in relative prices and the allocation of resources-Firms don't all raise prices at the same time,so relative prices can vary which distorts the allocation of resources to their best use.The consumer decisions also gets distorted.

5) Tax Distortions - Inflation makes nominal income grow faster than real income.Taxes are based on nominal income and some are not adjusted for inflation.So,inflation causes people to pay more taxes even when their real incomes don't increase.

6) Arbitrary redistribution of wealth - Higher than expected inflation transfers purchasing power from creditors to debtors-debtors get to repay their debt with currency that aren't worth as much now.

Lower than expected inflation transfers purchasing power from debtors to creditors.

High inflation is more variable and less predictable than low inflation.So,these arbitrary redistributions are frequent when inflation is high.