Question

Describe the relationship between inflation levels in prices and inflation levels, wages and interest rates with respect to their ability to affect people's economic status and business outcomes.

Answer 1

Inflation level in Prices and inflation levels are like taxes on a consumer which is being paid by the consumers at the time of purchasing commodities for consumption. High level of inflation actually impoverish the consumers and have a negative effect on their economic status. The business outcomes get boosted due to inflation in short run because the producers feel enriched due to nominal increase in price level of their products but in long run this illusion is removed and output levels return to natural levels.

Real wages i.e (W/P) price adjusted wage rate tend to fall when inflation takes place. This lowers the purchasing power of the consumers and their economic status decrease. Fall in real wages boost business outcomes since the rise in prices make the producers feel that they are gaining more profit out of business.

Interest rates in real terms i.e ( i - π ) where i is nominal interest rate and π is inflation level or increase in price levels, falls when inflation increases. This benefits the debtors, the ones who have taken loan. So the consumers who have to pay back interest rates are benefitted since they have to pay less in real terms and their economic status increases. Also business outcomes boost when real interest rates fall.