Question

Discuss the effects of inflation on production.

Answer 1

The effects of inflation on production are as follows:

1. Misallocation of Resources: Inflation disrupts the smooth working of the price-mechanism. It leads to maladjustments in production. Producers divert their resources from the production of essential commodities to non-essential goods (i.e., luxury goods) from which they expect higher profits. 
2. Reduction in Saving: Inflation adversely affects savings. When prices rise rapidly, more money is now needed to buy the same amount of goods and services than before. It, thus, reduces saving and hence investment. As a result, production is adversely affected.
3. Discourages Foreign Capital: Inflation discourages the inflow of foreign capital into the country. Foreigners do not like to invest in those countries where prices are rising. Rising costs of raw materials and other inputs make the foreign investment less profitable.
4. Hoarding: During inflation, the hoarding of larger stocks of goods becomes profitable. As a result of this, the available supply of goods in relation to increasing monetary demand decreases. This results in black-marketing. The producers then sell their goods in the black-market which increases inflationary pressures.
5. Fall in Quality: Inflation tends to create a sellers' market. Sellers have now got the command on prices because of excessive demand in the market. Anything can be sold in such a market. Therefore, sellers do not bother much about the quality of goods produced by them; instead they concentrate more on earning high profits.