Question

Why is it likely that a macro economy that suffers from inflation will become less competitive internationally?  (Use the unit labor cost concept to answer this question)

Answer 1

Case Specifics: -

An economy that suffers from inflation, depreciates in terms of the value of its currency in the market. This is because the supply of this currency exceeds the demand for it.

As a result, manufacturers get lesser money for the exports which they make in the international markets and would therefore get lesser profits and increased cost of production.

This increased per unit cost of production and labour, would mean that other competitors in the market would be able to sell the goods at a relatively cheaper price as their per unit cost would be relatively lower.

The resultant would be that the competitiveness in the international market would be lower for domestic companies.

This can be explained further with the following example: -

Supposing that there is inflation in a country which increases the supply of money in circulation. This reduces the overall exchange rates for it. The resultant is that exports lead to lesser inflow of money for the country.

If you were a company which produced in such a country, the end result would be that the amount of profits which you would generate would decrease substantially.

As a result of this, your profits would decline and the cost per unit of labour would increase as the returns reduce. This would also affect the competitiveness as other manufacturers internationally have stable currencies and can continue to supply with equal effectiveness and costs.

Please feel free to ask your doubts in the comments section.