Effects of Inflation | A-Level Economics Model Paragraph

Disadvantage of Inflation

Inflation is damaging to the economy as it can cause a wage-price spiral. Inflation is when there is an increase in the average price level in the economy. When workers see an increase in the rate of inflation, they realise that the cost of living will be rising, therefore they will bargain for higher wages. When firms have to increase wages, their costs will rise. This means that they may lay off some workers or increase prices even further to meet their rising costs. This causes further inflation, which reinforces the wage-price spiral. Additionally, inflation and the wage-price spiral can have unequal effects on the economy. Skilled workers are more likely to be accepted when they bargain for pay rises, whereas low-skilled workers are more likely to be stuck on lower wages or even replaced by machinery. This creates inequality and makes the cost of living crisis even worse for those on low incomes.

Advantage of Inflation

However, inflation can be a sign of economic growth especially if there is demand-pull inflation, which is caused by higher levels of aggregate demand. As prices are rising, people are more inclined to spend rather than save as the real value of their savings would be falling. For example, buying a house would be cheaper now than in the future as the value of it would only increase. This means that it makes sense to take out a mortgage before or during periods of inflation. Additionally, periods of high economic growth and high inflation can allow the government to collect more tax revenue due to higher consumption, incomes and profits.

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