Explain how inflation can be costly even if it is expected
What will be an ideal response?
There are four costs of expected inflation.
1. Seigniorage - the government's profit from issuing fiat money; also called the inflation tax. When the government increases the money supply, this causes inflation and the purchasing power of money decreases.
2. Shoe-leather costs - the costs of inflation to households and firms due to holding less money and making more frequent trips to the bank or ATM.
3. Tax distortions - changes in expected inflation can change the real, after-tax cost of borrowing.
4. Menu costs - the cost to firms of changing prices due to reprinting price lists, informing customers, and angering customers.
You might also like to view...
Fast Copy is a perfectly competitive firm. The figure above shows Fast Copy's cost curves. The current market price is 2 cents per page. With no change in demand and technology, in the long run, the price will
A) remain unchanged. B) rise to 5 cents per page. C) rise to 4 cents per page. D) fall to 1 cent per page.
For the following questions assume the following facts:
(1 ) Balance of Payments = 0 prior to the transactions. (2 ) Person A (who lives in the United States) purchases an airplane from British Airways for $150,000. (3 ) Person A pays with a check from his account at First Union Bank in the United States. (4 ) British airways, since it will need dollars in 1 month, deposits the check at the Bank of England. (5 ) Bank of England deposits the $150,000 at Commonwealth bank, which is located in the United States. Due to the transactions above, what are the effects on the reserve at the Fed? A) Fact 2 is a decrease of $150,000, fact 5 is a decrease of $150,000, a net effect of -$300,000. B) Fact 3 is a decrease of $150,000, fact 5 is an increase of $150,000, a net effect of 0. C) Fact 3 is an increase of $150,000, fact 5 is a decrease of $150,000, a net effect of 0. D) Both fact 3 and fact 5 result in increases of $150,000, a net effect of +$300,000. E) Both fact 3 and fact 5 result in decrease of $150,000, a net effect of -$300,000.