Chapter 14, Problem 1FRQ

a)

To determine

The question requires us to determine the net cost imposed by inflation with an appropriate explanation.

Explanation of Solution

Due to high inflation, workers have to run to banks frequently which causes their transaction costs to increase.

Here, inflation is imposing an economic cost referred to as shoe-leather cost.

So, inflation is imposing a net cost on the economy.

Economics Concept Introduction

Inflation represents a general increase in the prices of goods and services in the market, and the inflation rate represents the percentage rise in the overall price level in an economy in a given period of time.

Inflation imposes economic costs on the market. The major economic costs are:

• Unit of account cost
• Shoe-leather cost, and
• Menu cost

Due to inflation, an increase in transaction costs in terms of the extra running around banks and ATMs when people attempt to avoid keeping money, are called "shoe-leather costs."

b)

To determine

The question requires us to determine the net cost imposed by inflation with an appropriate explanation.

Explanation of Solution

Due to an increase in inflation, the money Lanwei receives as reimbursement has less value than the actual spending on travel. So, she prefers not to travel for her work.

Here, a fall in the value of money caused by inflation represents unit-of-account costs incurred by Lanwei.

Therefore, inflation puts a net cost on the economy.

Economics Concept Introduction

The economy experiences unit-of-account costs of inflation when inflation makes money a less reliable unit of measurement.

c)

To determine

The question requires us to determine the net cost imposed by inflation with an appropriate explanation.

Explanation of Solution

An increase in inflation benefits Hector as he has to pay a less-valuable rate to the bank. Due to inflation, the nominal rate rises which hurt the bank and benefit the customer who has taken loans at the fixed interest rate. So, there is no net cost to the economy due to inflation.

Economics Concept Introduction

Inflation indicates an increase in the general prices of goods and services in a market. Lenders, savers, and individuals with fixed incomes are hurt by the inflation while borrowers gain from the inflation.

d)

To determine

The question requires us to determine the net cost imposed by inflation with an appropriate explanation.

Explanation of Solution

Due to an increase in inflation, the firm needs to reprint the brochures with the correct rental prices this season.

Reprinting the brochures is an example of menu costs imposed by inflation.

Here, inflation puts a net cost on the economy.

Economics Concept Introduction

A menu cost is a real expense associated with changing a quoted price. For instance, to alter a price in a grocery shop, a clerk may need to alter the price written next to the item on the shelf and an office assistant may need to alter the price written on the store's computer.