Question

Identify and explain 3 costs associated with inflation

Describe the shape of the short run Phillips curve and what it suggests about the relationship between inflation and unemployment

Answer 1

The three costs associated with inflation are the following.

a. Menu cost: It is the cost associated with changing price lists and menu cards whenever there is inflation in the economy.

b. Shoe leather cost: This is the cost incurred due to making more visits to bank because they run out of cash due to increased prices.

c. Income redistribution: Due to inflation, borrowers are better off and lendors are worse off.

The shape of short run phillips curve is roughly L shaped. It depicts an inverse relationship between inflation rate and unemployment. As unemployment rate increases, inflation rate falls.