Question

How does inflation from one year to the next limit the spending power of households? During periods of high inflation, why might consumers be more inclined to spend their paycheck rather than save it for later consumption?

Answer 1

• Inflation refers to the rise in the general price level of an economy.
• It usually occurs when the federal reserve increases the money supply in the Economy using the expansionary monetary policy.
• Inflation increases the prices of goods and services, which limits the purchasing power of various businesses and households.
• The households that are highly dependent on various goods and services like the coffee, petrol etc for their daily consumption face depreciation in their purchasing power due to the rising prices during inflation.
• Even though they loose their purchasing power during Inflation, the households are more inclined to spend their paycheck now rather than save it later for consumption.
• This is because, inflation is a period of rising monetary value, hence after inflation there is a fall in the value of money.
• So the Households prefer spending their money when it's value is high to get higher returns, rather than spending it after Inflation when the value of money decreases.