Question

9. There are many kinds of costs of inflation to a society. Explain THREE such costs of inflation which are relevant to business firms.

Answer 1

Companies usually tend to low and steady inflation. When inflation rises above 3 or 4 per cent, businesses can see cost and uncertainty rising. Inflation may also cause companies problems with increasing prices, declining productivity and increased international competitiveness. Inflation, however, is not inherently harmful to a firm – particularly if it can boost prices for products more than its production cost increases.

Menu costs- These are the costs associated with adjusting price lists. If inflation is high, then businesses will need to change their prices more frequently. For that there are risks involved. This high inflation may be especially harmful for businesses like Pound / Dollar shops, as it is harder to find products that can be priced for a Pound. Modern technology does however make prices much easier to alter than before. You don't need to manually adjust rates these days because you can update barcodes and it's less time consuming.

Uncertainty- If inflation is higher than expected then investment costs will also change. This makes companies less likely to invest because they are unsure about potential prices, salaries and demand in the potential. This is particularly an problem with unforeseen cost-push inflation increasing the cost of raw material. This is probably the biggest inflation risk for businesses – high inflation causes confusion and can result in lower growth.

International Competitiveness- A higher rate of inflation than our rivals would also result in exchange rate depreciation; this will help restore profitability but at the cost of more expensive imports and a reduction in living standards.