Question

Fully explain why unanticipated inflation can decrease the level of economic activity

Answer 1

Answer - Unanticipated inflation is what has not be anticipated from before. This type of inflation lead to several downturns in the economy. The lenders are at losses , because in real terms , less money is repaid to them because of rise of rate of inflation in economy. The increased salary and wages are not enough to combat the effect of the rise in price level. The price level rises much faster and the net effect is the fall in consumption. The investments fall due to lower returns and the price level rise leads to costlier inputs leading to rise in cost of production. This leads to the fall in supply of the economy. Hence the unanticipated inflation leads to the negative impact on the economy with the declining Real Output and falling value of currency.