Question

The costs of expected inflation arise because productive resources are diverted from their most efficient allocation. Explain how each of the following costs of expected inflation distort the allocation of productive resources:

a. Shoeleather costs

b. Menu costs

c. The inconvenience of a changing price level

Answer 1

Answer-

a. Shoeleather costs-
To save on losing interest in a bank people will hold less cash and make more trips to the bank.

b. Menu costs-

This is the cost of changing price lists. When inflation is high, prices need frequently changing which incurs a cost.

However, modern technology has helped to reduce this cost.

c. The inconvenience of a changing price level-

When inflation is high, people are more uncertain about what to spend their money on. Also, when inflation is high, firms are usually less willing to invest – because they are uncertain about future prices, profits and costs. This uncertainty and confusion can lead to lower rates of economic growth over the long term. This is one of the main concerns about high inflation rates. Countries with low and stable inflation rates – tend to have improved economic performance over countries with higher inflation.